INVESTMENT MERIT

We are bringing a closure to our previous ‘Trading Buy’ call on HHGROUP given the weaker oil palm EFB fibre demand from China coupled with the competitive scene within their mattress division. We are projecting FY17-18E CNPs of RM3.1-3.2m. Not Rated with a Fair Value of RM0.32 based on 1.24x FY17E PBV.

It’s been challenging since... our last trading buy call with a fair value of RM0.51 back in January 2015. HHGROUP’s share price peaked at a high of RM0.81 in November 2015 attributable to their strong earnings performance. However, share price had corrected to lower levels due to poor results registered in FY16. To recap, FY16 CNP dipped 99% to RM0.04m on the back of lower revenue contribution from Biomass (Fibre products) segment (-7%) coupled with weaker PBT margins (- 16.4ppt) due to lower volume and ASPs for Biomass products as demand from China weakened.

Slowdown in China. A majority of HHGROUP’s manufactured oil palm EFB fibre is exported to China (c.90%) and their China clients are predominantly involved in the furniture industry. Hence, we believe the dwindling demand for oil palm fibre in China is due to weaker demand for furniture in China underpinned by the slowdown in residential developments. On the flipside, we note that HHGROUP purchases raw materials in MYR but sells to China clients in USD/RMB. Hence, HHGROUP could gain from the strengthening of USD against MYR. Our analysis indicates that a 10.0 sen depreciation of MYR against USD would increase FY17E CNP by c.RM0.5m (+16%). Currently, our USD/MYR assumption is pegged to our in-house USD/MYR target of 4.40.

Expanded in a tough time. From 2Q17 onwards, HHGROUP’s new plant in Gua Musang intended for oil palm EFB fibre manufacturing is expected to be operational. However, we are lukewarm on the additional 35,000MT (+35%) capacity given the weaker demand from China since 2H15 as mentioned above. Considering that c.90% of oil palm EFB fibre is exported towards the China market, we foresee utilization rate for new plant to remain low. In addition, we expect depreciation expenses to increase c.20% in FY17 from the commencement of their new plant. Balance sheet wise, HHGROUP’s net gearing has also increased to relatively high level of 0.58x in FY16 (vs 0.10x-0.29x in FY14-FY15).

Hard mattress. HHGROUP’s mattress division which does OEM and OBM manufacturing has been suffering losses in FY14-15 and was barely profitable in FY16 - only registering PBT of RM0.47m on the back of RM24m revenue. We believe HHGROUP’s OBM mattress division is plagued by intense competition against more well-known brands, i.e. Getha, King Koil, and Goodnite, coupled with the rising raw materials cost for mattresses, i.e. spring (steel +59% YoY) and rubber (+39% YoY); we believe their profitability for mattress division in FY17 would continue to be subdued.

Earnings forecast. We are projecting FY17-18E CNP of RM3.0-3.4m based on FY17-18E utilization rates of 68-70% for HHGROUP’s total capacity (including their newly installed capacity).

Not Rated at RM0.32. We are closing our previous position for HHGROUP with a Not Rated call at a Fair Value of RM0.32 based on FY17E PBV of 1.24x (-0.5SD 3 year Fwd PBV). We had ascribed a - 0.5SD valuations to HHGROUP given the weak oil palm fibre demand anticipated from China coupled with the rising raw material costs for their mattress division. Also, we opt to value HHGROUP based on PBV methodology instead of PER due to its volatile profits on the back of China’s economic uncertainty. We also note that our 1.24x PBV valuation is fair as it is the average PBV range of small cap peers who are operating in the furniture industry.

Source: Kenanga Research - 11 Apr 2017