Investment Considerations
1) Highly competitive domestic market but balanced with acceptable geographical diversification.
Small player with global presence but does not command meaningful market share. Over 50% of the revenue is
contributed from overseas hence significantly reducing their reliant on domestic market and well positioned to benefit from weaker MYR.
Our analysis is limited as they do not provide additional information on the profit by country. However, it does discuss that 20% strengthen in USD/MYR would lead to around 9% increase in net profit (source: FYE 2015 audited report). Walmart procurement of Jaycorp’s furniture will greatly enhance its reputation. With US housing starts to recover, it may benefit from the robust growth.
The website reports that it has 36 chambers which will provide uninterrupted access to rubber wood supply.
2) Volatile cash flow generation weakens its predictability but acceptable. Sustainable capital structure with high headroom to leverage its balance sheet.
Swings in working capital combined with unpredictable capex spending have led to volatile cash flow generation.Free cash flow (FCF) margin range from negative to c. 10% and quite unstable in our view. In recent FYE 2016, the improvements in FCF generation were attributable to low capex spending and positive working capital.
Cash flow is acceptable in the sense that the Fund from Operations (disregard the working capital distortion) is in the range of 6% to 9% and quite stable. Hence, the uncertain direction of working capital continues to make it difficult to project future cash flow. Low leverage certainly provide sizeable headroom to further borrowing should the company wishes to expand its operations.
3) Little evidence suggests the company is outperforming its competitors.
Relatively speaking, there is no substantial evidence of that Jaycorp is outperforming the competitors in financial performance metrics (refer to peer comparable in page 3). We valued Jaycorp using relative valuation assigned equal weighting on five multiples. Fair value derived suggests 11.33% (target price of RM 1.50) and we assigned a neutral rating which is consistent with our rating recommendations.
Key Takeaways from peer comparable:
- We remain sceptical on the investment metrics of Poh Huat as it seems too good to be true (significantly below peers’ average in previous FYE) but nevertheless, we have checked our data numerous times to ensure the accuracy but found nothing suspicious.
- From the list, we can see that the financial performances of SK (Sern Kou Resouces) and SWS (SWS Capital) were underperformed in terms of profit margin, liquidity and leverage. Share prices, surprisingly, were breaking new highs.
- The companies, in generally, were not highly leverage (except for SK and SWS) with satisfactory interest coverage.
- We viewed that the capital structure of SK and SWS as close to non-investment grade border with Debt/EBITDA at 5x as of last financial year end.
- Profit margins, as explained previously, were suggesting the industry is not highly lucrative. Latitude (LL), in our view, is a better company in terms of profit margin, cash flow generation, good liquidity profile and sustainably low leverage. However, as those metrics are historical, we need a longer horizon and latest figures to form a better judgement.
- Based on the peer comparable, limited metrics did not revealed that Jaycorp is an attractive company relative to its competitors. However, its investment metrics were below its peers in current FYE.
- Recent better than expected financials combined with multiples expansion have led to share price increased by almost 40%
Valuation
Working capital and capital expenditure uncertainty have increased the difficulty of projecting the future cash flow generation. Hence, for the valuation, we adopted relative valuation to compare five mostly used investment metrics which we are sure most investors would know.
Please be aware that the limitations of our valuation methodology are (but not limited to):
- Our observations are not comprehensive (only eight observations)
- Future directions (ie multiple contractions and expansions) are not considered.
To reduce our likelihood of overestimating fair value, we have eliminated any outliers. In general, we do agree that some companies might deserve premiums due to outstanding performance against peers. For Jaycorp, a premium is not justifiable given the industry is not highly lucrative and average performance against the peers.
Should there be any favourable USD/MYR, and interest rate hike in US, Jaycorp and other export oriented companies might experience multiple expansion. We do not have a strong opinion on whether the rate hike is highly likely in coming months. Should the readers believe a rate hike is possible (in theory will strengthen the USD/MYR), feel free to adjust multiples to reflect your views.
For EBITDA, Revenue and Net Profit, we have used last twelve months figures while Market Capitalization and Enterprise Value are obtained from Gurufocus.com.
We believe that the fair value is around RM 1.50 with an estimated upside potential of 11.33%. Today (10/10/16) Jaycorp’s share price has increased significantly, and close to our fair value. We assign a neutral rating on the stock.
Key Investment Risks
- Weak domestic and global consumption
As the goods are not considered essential by nature hence any weak consumer sentiment would lead to delay in consumption. Malaysia’s operations would be one of the first to experience drop as cost of living and weaker MYR will have a negative effect in the long run.
- Increase use of 2nd hand furniture
The substitutions could be an increase use of 2nd hand furniture as it is cheaper alternative than purchasing new products. However, the effect of this is still uncertain as tear and wear might still result in purchase of new furniture.
- Intensify competition to winning orders
Although it has a good reputation and has history with Walmart, they are price takers rather than price makers therefore any competition would lead to lower margins. Significant reduce the attractiveness of the industry that already offers single digit profit margin, on average.
Investment Ratings
Buy = Share price may exceed 15% over the next 12 months
Neutral = Share price may fluctuate within the range of ± 15% over the next 12 months
Sell = Share price may fall more than 15% over the next 12 months
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Investment Research Disclaimers
- The opinions and views expressed in this report are solely of the analyst.
- Any projections or estimations may not be accurate. Market conditions and assumptions could result in materially different outcomes.
- Past performance is not necessarily an indicative of future performance and the analyst will not accept for any loss arising from information contained in this report.
- This report is not intended as an offer to buy or sell the securities discussed.
- Seek independent advice to understand the investment risk arising from taking investment actions based on this report. Consider your unique circumstances (such as time horizon, liquidity and risk tolerance) before investing as not all investment are suitable for every investor.
- The analyst currently has no financial interests with the company analysed in this report. The company has not paid the analyst to write this research.
- The analyst currently has no shareholding in the company analysed in this report.
- The analyst may invest in the company analysed in the future but will only do so after 48 hours of publishing of this report.
This research is provided by Jackson Yuen, a credit analyst at the Bank of East Asia. He is passionate about credit analysis and equity research. He is currently analysing listed companies in Malaysia to provide Malaysian investors with more comprehensive analysis. Due to the nature of his work, he focuses heavily on the cash flow generation and the sustainability of the capital structure. Please visit his website.
