This article first appeared in The Edge Malaysia Weekly on April 17, 2017 - April 23, 2017

MIECO Chipboard Bhd, whose share price touched RM2.40 last week, has been trading at multiple-year highs after surging more than 173% over the past year. But its valuation still lags that of its peers. It could catch up, though, if its new management’s turnaround plans bear fruit.

Closing at RM2.16 last Friday, Mieco’s trailing 12-month price-earnings ratio (PER) was 5.49 times, which is lower than HeveaBoard Bhd’s 7.69 times, Evergreen Fibreboard Bhd’s 10.01 times and SYF Resources Bhd’s 9.08 times.

Some industry observers believe that Mieco could close the valuation gap if its revamp initiatives successfully lead to lower costs, higher efficiency and better margins.

A key difference between Mieco and its domestic peers is the company is coming from a lower base and has more room to enhance its operations.

“Its peers are already producing high-end products, with limited room for capacity and selling prices to rise further,” says a senior industry official. “In comparison, Mieco can still increase its output significantly and is also capable of eventually shifting to premium products for better margins.”

It is noteworthy that Mieco mainly produces E2 and E1 grade particleboard while HeveaBoard and Evergreen have switched to producing higher-value E0 and super E0 categories, say analysts.

An industry official says Mieco is capable of producing E0 and super E0 boards but only lacks the necessary certification at the moment.

In a note last week, UOB Kay Hian says E0 and super E0 boards command net margins of 20% to 22% versus 15% to 17% for E1 boards, and 12% to 14% for E2 boards. It has a “buy” call on Mieco, with a target price of RM3 a share.

The company’s German-made machinery is able to produce more consistent product quality, which is an advantage when shifting up to premium products, the industry official points out.

That said, Mieco needs to regain the Japanese Industrial Standards (JIS) certification for E0 and super E0 boards. The standards are used for industrial activities in Japan. The company lost the JIS rating last August and aims to regain it by 2019.

Recall that the company saw a new majority shareholder emerge last October. Datuk Seri Ng Ah Chai bought a 56.76% stake from BRDB Developments Sdn Bhd for RM107.27 million or 90 sen per share.

Ng, who is now Mieco’s managing director, is also executive chairman and majority shareholder at SYF Resources.

In an interview with The Edge Financial Daily last month, he outlined his plans for Mieco, which is expected to see double-digit revenue growth in the financial year ending Dec 31, 2017 (FY2017), and improve its gross margins from between 12% and 15% to the industry average of 15% to 18%.

For FY2016, the company’s revenue fell 8.7% year on year to RM324.1 million while net profit more than quadrupled from RM18.6 million to RM82.7 million. Its top line last grew by a double-digit percentage in FY2015 when its annual turnover rose 10.3% y-o-y, based on Bloomberg data.

One of Ng’s immediate focus on his entry into Mieco was to manage its costs. The company’s two largest cost components are rubberwood and glue, which made up 32% and 30% of its cost of sales respectively in FY2016.

These figures have since fallen to 30% and 28% after it exercised more stringent control over raw material procurement, says UOB Kay Hian.

Mieco now has a tender system for its glue purchases while its drying process for rubberwood and sawdust materials is now more energy efficient due to new moisture control guidelines.

The company has also begun improving its operational efficiency, the research house notes. Its previous customer-centric model involved more downtime and higher defect rates, which depressed its utilisation rates.

Moving forward, the plan is for Mieco to be more production-oriented by adopting common colours and sizes for its products, says UOB Kay Hian. The company has ceased its paper-lamination processing and customisation workshop units, which had bled about RM7 million collectively per annum.

While its longer-term plan is to eventually shift into higher-margin premium products, Mieco’s short-term focus is to capitalise on a supply shortage in the E2 boards segment.

To recap, China’s five-year economic plan — unveiled last year — included pollution-control targets that have led to about 30% of the country’s particleboard manufacturers shutting down. This disrupted supply that had already been pressured by strict logging restrictions beginning 2015, which hurt raw material supply.

“Moreover, demand from India, Indonesia and Vietnam is expected to rise, supported by growing demand for furniture, on the back of population growth,” UOB Kay Hian writes. “We expect the tightening supply of raw materials and steady demand for particleboard to lead to firmer prices going forward.”

The benefits are already visible, the research house says, noting that Mieco’s average selling price has increased by up to 15% since February.

That said, only 20% of Mieco’s earnings are from the overseas market. UOB Kay Hian estimates that a weakening of 5% of the ringgit versus the US dollar would lift the company’s net profit by up to 2.2%.

In the longer term, Ng’s presence in both Mieco and SYF Resources raises the possibility of a merger that would solidify the former’s position as Malaysia’s largest particleboard manufacturer, says UOB Kay Hian. The companies have a combined production capacity of over one million cu m per annum, it adds.

At present, Mieco has a particleboard production capacity of 900,000 cu m per annum from its two plants in Gebeng and Kuala Lipis in Pahang. It produced 450,000 cu m in FY2016 and aims to increase that to 600,000 cu m this year, raising its utilisation rate to 85%, Ng said last month.

“We believe an acquisition could entail a potential amalgamation of SYF Resources’ board division into Mieco or vice versa that would allow the group to compete on a regional scale with the larger Thai particleboard manufacturers,” says UOB Kay Hian.

However, the research house cautions that rising raw material and labour costs are major risks for Mieco, especially as rubberwood log prices have risen 10% year to date, thanks to a rebound in latex prices that delayed replanting activities.

“Meanwhile, competition for locally sourced rubberwood raw material among peers within the board segment (such as Evergreen Fibreboard and HeveaBoard) could intensify if replanting activities slow down, and this could crimp margins,” says UOB Kay Hian.

Furthermore, Mieco could be hurt if downstream furniture manufacturers such as Poh Huat Resources Holdings Bhd, Lii Hen Industries Bhd and Jaycorp Bhd lower their selling prices to remain competitive, it adds.

Overall, the research house expects the company to see a net profit compound annual growth rate (CAGR) of 56% between 2017 and 2019, as its utilisation rate increases and production mix shifts to higher-end products.

Based on its projected operating cash flow of between RM63 million and RM87 million for the three years, UOB Kay Hian expects Mieco to be able to pay between 15 sen and 21 sen per share in annual dividends during the period.

This assumes an annual capital expenditure requirement of RM20 million and loan repayment of RM5 million to RM10 million, the research house says. “This translates into attractive 2017 to 2019 yields of 6% to 9%.”

Save by subscribing to us for your print and/or digital copy.

P/S: The Edge is also available on Apple's AppStore and Androids' Google Play.