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Monday, December 22, 2014

(Icon8888) Focus Lumber - Tug Of War Between Strong US Dollars and Strong Log Prices

1. Introduction

Malaysia's economy and stock market had been turned upside down over past few weeks. Decline of oil prices has turned domestic oil and gas companies from darlings to outcasts. At the same time, the weakening of Ringgit improves the outlook of export oriented companies. Same as many other punters, I scramble to try to identify companies that can benefit from the latest trend. It is against this backdrop that I started looking at Focus Lumber Berhad ("FLB").



2. Background Information

FLB is a Sabah based company controlled by several Taiwanese families. It is principally involved in manufacturing of plywood, veneers and other related products. Almost all its products are exported (US 67%, Taiwan 12%, South Korea 9.5%, Malaysia 7.4%, others 4.8%). As the bulk of its revenue is denominated in US Dollars, it could be a beneficiary of strong US Dollars.

Based on 103 million shares and share price of RM1.05, FLB has market cap of RM108 million. They reported net profit of RM15.1 million in FY2013. As such, PE multiple is 7.2 times only.

Based on net assets per share of RM1.37, PBR is 0.77 times.

The group has zero borrowings and cash of RM59 mil. Cash per share is 57 sen, representing 54% of existing market cap.

Over the past 2 years, the group paid out dividend of 8 sen per share per annum. Based on share price of RM1.05, dividend yield is 7.6%.  



Beginning Nov 2013, the company's share price spiked from 70 sen to reach all time high of RM1.50 in July 2014. Since then, share price has retraced to RM1.05 at the time of writing.


    
3. Historical Profitability

Over the past few years, the group has reported net profit within the range of RM10 mil to RM15 mil :-

     9 months
(RM mil)20102011201220132014
Revenue120.4122.2132.8147.2109.0
Net profit10.213.711.615.110.9
EPS (sen)9.913.311.314.710.6

The group's profitability is sensitive to currency movement. In Q1 and Q2 of FY2013, strong Ringgit caused gross margin and net profit to drop. Weakening of Ringgit from Q3 FY2013 onwards immediately boasted earnings. The correlation is pretty clear.
  
         9 months
(RM mil)Q1Q2Q3Q4FY2013Q1Q2Q3FY2014
Revenue31.339.237.439.3147.237.837.333.9109.0
Gross profit6.27.910.610.735.49.79.18.527.2
          
Other income0.90.31.41.33.80.51.21.12.9
Selling expenses(3.7)(4.6)(5.0)(5.4)(18.6)(4.4)(5.0)(4.4)(13.9)
Admin expenses(1.1)(0.8)(0.4)(1.6)(3.9)(1.1)(1.0)(1.1)(3.2)
other expenses0.0(0.2)(1.0)(0.2)(1.3)0.0(0.6)(0.8)(1.4)
          
PBT2.32.65.74.715.34.63.83.311.7
Tax(0.1)0.8(0.6)(0.3)(0.2)(0.6)(0.2)0.1(0.7)
Net profit2.23.45.14.415.14.13.63.311.0
          
Gross margin (%)19.820.128.327.324.025.624.325.025.0
PBT margin (%)7.46.715.212.010.412.310.19.610.7
          
USD : RM3.083.073.243.213.153.303.233.193.24



4. Risk Factors

According to the Company's IPO prospectus, the following are some of the risk factors that could potentially affect the group :-

(a) Log Supply - The group does not own any timber concessions and presently sourced its logs mainly from Sabah. To mitigiate supply risk, the group has entered into long term contract with suppliers.

(b) Labour Shortage - As at IPO, the group has 1,007 emplyees out of which 955 are factory workers (871 are foreign workers). Labour shortage could pose a problem to the group's operation. In the latest quarter ended 30 September 2014, the group attributed lower sales volume mainly to labour shortage.
   
(c) Log Prices - As the group uses logs as its main raw material, any increase in log prices will adversely affect its profit margin. In May 2014, Myanmar announced that it will stop exporting logs. This has caused log prices to strengthen. It remained to be seen to what extent this latest development will affect FLB. 

However, in the IPO prospectus, the company explained that

"We believe that the group is able to mitigate the risk of fluctuation in log prices given that if the prices of log increase over time, the selling price for plywood should likewise increase, and vice versa. In any event, all manufacturers will be similarly affected by the price increase of logs and should likely pass on the price increases to their respective customers. It generally takes about one to two months to pass on the price increase to their respective customers. The adjustment to the selling price would normally be reflected in the next price quotation to the customers. Nevertheless, the extent of any adustment to the selling prices would take into consideration the prevailing market demand for plywood and market acceptance to the price adjustment and to the extent that it would not materially affect the demand for our plywood products."

(d) Forex Exposure - In the IPO prospectus, the company explained that :-
"The bulk of the group's products are exported. The transactions are mostly denominated in US Dollars. In this regard, any weakening of the Ringgit against US Dollar would contribute favorably to the results of the group (and vice versa). "



5. Disposals By Substantial Shareholders

FLB is controlled by the following few Taiwanese families, collectively holding more than 50% equity interest :-

 (mil shares)(%)
Chen Family9.39.0
Lu Family21.220.5
Lin Family18.912.7
Yang Family12.312.3
TOTAL61.754.5

When I started studying FLB, one thing that immediately caught my attention was the series of disposals by two of its its major shareholders, Lu Wei Hsu and Chen Chun Hsiung :-

  sharesEstimated
SellerDatesoldPrice (RM)
    
Lu Wei Hsu26 Nov 14117,9001.16
Lu Wei Hsu25 Nov 14408,6001.15
Lu Wei Hsu24 Nov 1460,0001.14
Lu Wei Hsu20 Nov 14168,9001.14
Lu Wei Hsu19 Nov 14248,7001.15
Lu Wei Hsu18 Nov 14391,1001.15
Lu Wei Hsu14 Nov 14483,3001.19
Lu Wei Hsu13 Nov 14113,4001.20
Lu Wei Hsu12 Nov 14173,7001.16
Lu Wei Hsu11 Nov 14183,0001.16
Lu Wei Hsu10 Nov 14158,7001.18
Lu Wei Hsu7 Nov 1448,8001.21
Lu Wei Hsu29 Oct 14287,0001.15
Lu Wei Hsu28 Oct 14396,4001.14
Lu Wei Hsu24 Oct 1450,0001.19
Lu Wei Hsu23 Oct 14729,1001.17
Lu Wei Hsu21 Oct 1416,9001.18
Lu Wei Hsu17 Oct 14106,8001.15
TOTAL 4,142,300 
    
Chen Chun Hsiung3 Oct 1429,6001.28
Chen Chun Hsiung2 Oct 1472,0001.28
Chen Chun Hsiung1 Oct 1425,0001.30
Chen Chun Hsiung30 Sept 1460,0001.30
Chen Chun Hsiung26 Sept 1460,0001.30
Chen Chun Hsiung22 Sept 1420,0001.28
Chen Chun Hsiung3 Sept 145,0001.31
Chen Chun Hsiung2 Sept 1430,0001.29
Chen Chun Hsiung18 Aug 1410,0001.43
Chen Chun Hsiung15 Aug 142,0001.45
Chen Chun Hsiung7 Aug 143,0001.41
Chen Chun Hsiung6 Aug 1410,0001.41
Chen Chun Hsiung5 Aug 1410,0001.41
Chen Chun Hsiung4 Aug 145,0001.41
Chen Chun Hsiung31 Jul 1440,9001.41
Chen Chun Hsiung23 un 1410,0001.45
Chen Chun Hsiung3 Jan 1420,0001.11
Chen Chun Hsiung2 Jan 1410,0001.13
Chen Chun Hsiung27 Dec 1320,0001.32
Chen Chun Hsiung26 Dec 1340,0001.31
Chen Chun Hsiung24 Dec 1310,0001.22
Chen Chun Hsiung23 Dec 1310,0001.20
Chen Chun Hsiung18 Dec 1320,0001.20
Chen Chun Hsiung26 Nov 1336,0001.04
Chen Chun Hsiung22 Nov 1310,0001.04
Chen Chun Hsiung21 Nov 1310,0001.03
Chen Chun Hsiung7 Nov 1340,0001.07
Chen Chun Hsiung6 Nov 1310,0000.91
TOTAL 628,500 

The disposals happened over two different periods.

Chen Chun Hsiung, who owns 9.3 million shares, disposed of 0.6 million shares during the period from November 2013 and October 2014. A close inspection of FLB share price movement indicated that that was the bullish phase, whereby share price spiked in November 2013 from 70 sen to peak at RM1.50 in July 2014 and hovered around RM1.30 by October 2014. It seemed that the disposals were for profit taking purpose and not due to any deterioration in fundamentals. As a matter of fact, during that period, the group announced few quarters of commendable results. Chen's disposal ceased on 3 October 2014 at price of approximately RM1.28.

Lu Wei Hsu's disposals started on 17 October 2014 and ended on 26 November 2014 (a period of approximately one month). An inspection of KLCI chart shows that 17 October was the peak of the panic selling caused by recent Dow Jone's sudden collapses. Based on Annual Report, Lu Wei Hsu holds approximately 4.4 mil shares in FLB. After his recent disposals, his shareholding was reduced to a mere 250,000 shares. As far as he is concerned, the selling has almost been done (no more selling going forward). Meanwhile, his other family members continued to hold on to their shares estimated at 17 million shares (17% equity interest).

I interpreted Lu Wei Hsu's disposals as an effort to lock in value to protect his net worth. He might be unnnerved by a combination of the following recent developments : equity market volatility, upside risk of log prices and depreciation of Ringgit (will affect repatriation to Taiwan). It remained to be seen whether his recent disposals is a correct move. In any event, as mentioned above, he is now holding very small amount of shares and there will be no more major selling from him.

      
6. Concluding Remarks

(a) With the bulk of its products exported, FLB is a potential beneficiary of strong US Dollars.

(b) On the other hand, recent strong log prices is pulling the company in opposite direction, threatening to depress its profit margin. It is difficult to ascertain at this juncture which one of the factors will overwhelm the other.

(c) The group has strong fundmentals. It is cash rich and is generous in paying out dividend (dividend yield of 7.6% based on 8 sen dividend per share). Valuation is also reasonable with single digit PE multiple.

(d) I bought some at RM1.14 recently mainly for its attractive dividend yield. I have pocketed the 8 sen dividend. If the coming quarters results turned out to be ok and share price remained at current level, I will consider adding more.

Have a nice day.

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