Latitude - mispriced or mistake?

Furniture stocks have traditionally been viewed as cyclical and also exposed to foreign currency fluctuation as they are export oriented, hence their performances have been erratic and PE accorded to them are usually lower (below 10) as compared to other industries. There is no doubt that the fantastic performance for furniture stocks over the last 4 years  (2013 – 2016), to a large extent was due to weakening of RM. The recovering of US housing also helped to push up the volume for furniture industry. Now with RM started to strengthen gradually and the general expectation  that furniture industry has peaked, furniture stocks seems to lose its shine.

Personally, I agree that the growth may slow or take a slight dip in 2017, but in the longer term, I would have a slightly different view on this industry, based on the followings:-

1. Most, if not all the furniture stocks listed on Bursa are net cash companies and their financial positions have strengthened significantly, hence, it can sustain economic downturn better than many other industries eg steel, construction or property
2. Most of them have expanded their capacity, upgraded and automated facilities to counter the rise of labour cost
3. Expand into bigger markets for growth as well as improve on quality to enhance profit margin

One of the furniture stocks I have is Latitude.

Info from its website:-

History

Latitude Tree Holdings Berhad was incorporated in Malaysia as an investment holding company. Through its subsidiary companies, the Group specialises in the manufacturing and sale of wooden furniture and components particularly rubber-wood furniture for both the domestic and export markets.

The Group has carved out a strong niche in the household furniture segment, specifically dining and bedroom sets. From its humble beginnings as a manufacturer of chairs for dining sets in 1988, the Group has grown into a complete high- and-medium-end dining and bedroom sets manufacturer. About 60% of its raw materials are rubber-wood-based with the remaining being oak, pine wood and other wood-based materials.

The Group has made great advances to position itself as one of the largest rubber-wood furniture manufacturers and exporters in Malaysia and Vietnam. Approximately 99% of the Group's products are exported overseas to the United States of America, Canada, Europe, South Africa, Australia and the Middle East countries.

Manufacturing / Operating Activities

The Group's manufacturing activities are operated from its three factories in Malaysia, two factories in Vietnam and one factory in Thailand. The total floor area of the six manufacturing plants is approximately 7.8 million square feet. The total current workforce is about 7,500 workers.

Products

The Group has developed an extensive range of products to cater for different customers' requirements and expectations. The followings are the main products of the Group:

• Bedroom Collection Sets including Beds, Nightstands, Chests, Armoires and Wardrobes;
• Dining Collection Sets including Tables, Chairs, Buffets, Hutches, Curios, Sideboards and Servers;
• Living Room Collection sets including Sofas, Sofa Tables, Occasional Tables, Coffee Tables and Cabinets (TV and Low Cabinets) and Small Office, Home Office (SoHo) sets.

From the traditional piece-meal furniture, the Group has shifted strategically into the manufacture of whole set and collection set furniture as a response to the emerging demand trends for whole set and collection set furniture. The Group has a team of in-house designers, technicians and developers who are able to develop products that meet customers' requirements and tastes for different markets.

Past financial performance -RM'000 ( Note FY 30 Jun 17 – only consists of 9 months results)

	2011	2012	2013	2014	2015	2016	2017 (Q3)
Revenue	500,664	517,863	493,687	651,025	710,000	770,596	602,037
Cost of sales and services	443,008	464,346	422,485	541,182	592,110	633,935	501,512
Gross profit	57,656	53,517	71,202	109,843	117,890	136,661	100,525
Other operating income	4,317	1,772	2,538	3,531	12,226	6,103	10,512
Administrative expenses	(14,451)	(14,724)	(16,464)	(17,213)	(18,655)	(21,505)	(18,230)
Selling and distribution	(10,610)	(11,038)	(11,602)	(15,221)	(16,333)	(17,952)	(14,719)
Other operating expenses	(9,202)	(7,858)	(5,547)	(5,433)	(3,648)	(7,804)	(2,391)
Profit from operation, EBIT	27,710	21,669	40,127	75,507	91,480	95,503	75,697
Finance costs	(5,632)	(4,974)	(4,469)	(3,673)	(3,027)	(3,290)	(1,916)
Share of profit from associate co.	(331)	(45)	-	-	-	-	-
EBT	21,747	16,650	35,658	71,834	88,453	92,213	73,781
Taxation	(2,006)	(1,897)	(3,612)	(7,501)	(10,200)	(19,289)	(9,176)
Net Income	19,741	14,753	32,046	64,333	78,253	72,924	64,605
DPS (sen)	2	3	6	9	10	12	-
EPS (sen)	20.3	10.1	25.1	56.6	80.0	74.8	66.5

I tried to do a reverse DCF using forecasted FY17 to stay at FY16 level (though FY17 - 9 months results already at 89% of FY 16 full year), at share price of Rm 5.20, market is valuing Latitude on assumption it is expected to have negative growth of -2% per annum from FY18 onwards . Except for its dividend yield (only 2.3%), Latitude scores high in almost all metrics – good ROIC (20%), reasonably cheap with EV/EBIT of 4.2, PE 7. It is still reasonable from historical PE - band for last 6 years, ranged from 2 to 11.

(For purpose of this analysis, I have not and not sure how to factor in the possible action from one of its substantial shareholders, Mr Koon Yew Yin & wife who has accumulated since 2013 and started to sell since 2015/16 and still has quite a substantial amount of Latitude shares as per FY16 Annual Report). With all that financial checks, Latitude seems undervalued, question : - can it continue to grow its profit and cash?

Extract from FY16 Annual Report:-

1.The United States region remains the core market for the Group, accounted for approximately 93% of FY2016’s revenue. The remaining revenue contributions were from other markets. In line with our expansion plans, the Group plans to increase and explore other export markets with high growth potential such as Australia, Japan, Canada, China, Taiwan and Middle East countries.  
2.A new high-end production line and design center are in the pipe line to cater for production of small quantity high value products, enhance the design and development of new products and expedite the delivery of new product prototype to our customers at our Vietnam plants. With the completion of this investment, it will further improve our profitability in years to come. 
3.In order to reduce reliance of low-skilled labour and to improve production efficiency, the Group has allocated RM24.0 million to upgrade or automate existing production lines with advanced automation and state-of-the art technology machinery.

But then why – the stock price has come down a lot (from Rm 8 to Rm 5.2, >30% down) when the company’s performance is at least on par with FY16? Intrinsic value I calculated using Discounted Cash Flow is Rm8.1, with 36% margin of safety at current price Rm5.20.

Based on the analysis, I would still keep Latitude though I am currently having a paper loss of 2.3%.