HOMERIZ (5160) HOMERITZ CORPORATION BERHAD - HOMERIZ - The Usual Suspects (B)
Introduction
While
writing this post, we visited some online investor communities and
found that HOMERIZ has been widely covered by many independent analysts,
as it aligns with US beneficiary theme. However, we feel reluctant to
give too much credit for good business performance that is backed by
external factors like foreign currency exchange rates. Therefore, in
this Business Analysis post of HOMERIZ, we use a different approach by
naming out The Usual Suspects as main factors to consider when analyzing HOMERIZ.
Business
But
first, let us present the business of HOMERIZ. Founded in 1997, HOMERIZ
is an integrated designer, manufacturer and exporter of a complete range of upholstered home
furniture, comprising leather and fabric-based sofas, dining chairs and bed frames.
The upholstered home furniture have various ranges which are mainly
focused on “medium to high end range”. The company currently exports its
products to more than 50 countries mostly in Asia and Europe.
Taken from HOMERIZ FY16 Annual Report
The Group primarily undertakes Original Design Manufacturing (ODM) and Original Equipment Manufacturing (“OEM”) activities; where ODM contributed
around 80% of the group revenue and OEM contributed the remaining. ODM
creates new product designs and specifications based on the product idea
brief provided by the client (therefore comes with better margin),
while OEM
manufacture products based on the product design and specifications provided by their client.
Homeritz has also created its own brand of lifestyle furniture series under “Eritz”.
Future Growth
Going
forward, the Group aims to keep its customer base diversified with a
plan to put greater emphasis on the South America market in FY17.
The
Group is also on track expanding its production capacity. Currently,
the Group has four existing production lines and the fifth factory is
expected to operate in 2Q17, which will expand HOMERIZ capacity by 15%.
The Group has also bought 10 acres of land within Bukit Bakri Industrial
Park at Muar in 2015, which shows its determination for future
expansion, particularly in consolidating in operations to
improve efficiency and cost savings.
However,
an increase in production capacity would not necessarily result in a
proportional increase in revenue as demand is equally important in the
formula. The increase in supply without demand would result in price
competition and margin compression.
To
our satisfaction, the Group plan to stick to its core business, with
more efforts to develop new designs and focus more on manufacturing
made-to-order niche products, which will improve the Group profit
margin.
The Usual Suspects
Even
though HOMERIZ is largely involved in ODM, which allows it to create
more values and lead to better margin, we still think the business does
not have economic moat. We are not belittling the industry, and to be
fair to HOMERIZ, its simplistic, space saving and contemporary furniture
designs made it stands out amongst its competitors, and won several
awards including Malaysian Furniture Leasdership Award and Enterprise 50
Annual Award Programme 2008 & 2009. However, there are simply too
many competitors in the industry. The good design in furniture may give
HOMERIZ the upper hand in pricing (which we believe HOMERIZ has achieved
in a certain level), but it has no ability to lock their customers.
For
the likes of HOMERIZ, simple business without economy moat or growth
catalysts, they are usually less immune to external factors and more
cyclical in nature. Therefore, it is important to know the few external
factors affecting furniture exporters like HOMERIZ, also known as The Usual Suspects in this post.
# Usual Suspect 1: FOREX
You
must have read this somewhere. 99% of HOMERIZ revenue is denominated in
USD, while 40% of production cost is paid in USD. In other words,
HOMERIZ is totally a USD beneficiaries. The recent surge in USD has
gathered trading interest to obvious USD beneficiaries like HOMERIZ, but
the other side of the coin is that reversal in USD can create the
opposite effect. And God forbid, even if MYR continues to weaken against
USD, there will only be limited advantage for a company who benefits
solely on currency translation, as competitions will come in and
equilibrate the situation. All in all, our focus should be, what would
HOMERIZ results have been if there wasn't a surge in USD against MYR
since 2014? (In case you wonder, yes we do have an answer for this, but we will save it for next post in Financial Analysis).
In
regards to Bank Negara Malaysia measure that requires exporters to
convert at least 75% of their proceeds into MYR, HOMERIZ founder and
managing director Chua Fen Fatt said it will have a minimal impact on
company. We agree on this point because exporters can hedge their
positions with financial instruments as it has always been practiced by
HOMERIZ.
Presented
earlier, HOMERIZ is less impacted by geographic factor as the Group has
been exporting to over 50 countries despite 99% of the revenue received
is in USD.
# Usual Suspect 2: RAW MATERIAL
In
the wide range of products manufactured by HOMERIZ, the signature
material is cow leather. Furnitures with cow leather requires skilled
works and higher capital, therefore providing competitive advantage to
HOMERIZ. Leather accounts for 40% of total production cost of HOMERIZ.
As mentioned earlier, 40% of HOMERIZ production cost is in USD, we
believe it is mostly referring to the cost of purchase of leather
material. Thus, let's study the main raw material of HOMERIZ, cow
leather.
We
are no expert in leather hides price, but let us shed some light about
the industry. The leather industry relies on by-products of the meat and
dairy industries for over 95% of its raw materials. Therefore, the
leather supply depends on the cattle population, and the cattle
population depends on human populations growth (meat and dairy
consumption). The ratio of cattle populations (by far the primary source
of leather raw material) and leather produced to the size of human
populations has remained remarkably steady for the last one hundred
years.
Taken from journal
While
the above data seems reliable with history track of one hundred years,
there are also evidence of potential serious discontinuities in such
trend. The world population is still growing rapidly, however, there is
some shift in eating habits, that is, less red meat consumption in
developed countries but more meat consumption in developing countries.
The scarcity of land and resources, coupled with issues of climate
change and other environmental concerns, cattle stock might not be able
to keep up human population growth. The industry has long anticipated
that the demand for leather would outstrip raw material supply, but yet
it hasn't happened yet. This is attributable to the introduction of more
replacement materials, either synthetic leather or non-mainstream
sources of raw material as camel, kangaroo, deer and pig with the
advancement of technology.
Or you may skip above paragraph and come to this conclusion: "predicting
price of leather hides (or any commodity for that matter) correctly and
consistently over the long term is impossible just as to predicting
foreign exchange rates."
But what are we going to present next is more interesting and
meaningful. Hides price went up dramatically in 2013, from the level of
80 US cents per pound to historical peak at USD 1.14 per pound in the
end of 2014 before a collapse. It is interesting to see HOMERIZ ability
to maintain its gross profit margin of over 40% in the period despite
the surge in cost of raw material (We will elaborate further in next post). This
suggests HOMERIZ ability to pass down its cost to the customers. At
time of writing, leather hides is trading at 70 over US cents per pound,
a low price that the management opines will sustain in near future.
Data collected form http://www.indexmundi.com
# Usual Suspect 3: Labour
HOMERIZ's
heavy reliance on skilled labour makes it the third usual suspect in
this post. In chairman statement of Annual Report FY16, it was mentioned
that the government's decision to freeze the hiring of foreign workers
in March 2016 has caused a major labour shortage and resulted in sales
volume decline in FY16, especially in 4QFY16. The government then
uplifted the freeze and approved HOMERIZ to bring in an additional 60
foreign workers in Oct 2016, and we immediately saw improvement in
Financial Report 1QFY17, with sales volume increased 20% compared to
preceding quarter. The managing director has also mentioned that skilled
labour is the biggest constraint for HOMERIZ to expand.
On
the other side, Employers Mandatory Commitment (EMC) which requires the
employers to follow some strict mandatories including bearing foreign
worker levy is another hot topic recently. EMC was attempted to roll out
in early 2017 but the government later deferred it till 2018 due to
backlash against the policy from employers. While the postponement of
the policy has been a relief to the industry, the government seems to be
determined to roll out EMC anyway to reduce employers reliance on
foreign workers. On the bright side, in a research report issued by HLIB
on 26 January 2017, EMC will have minimal impact on HOMERIZ as the
company has been absorbing levies since few years back.
The
freeze on hiring foreign workers and implementation of foreign workers
has sent investors a very important message, that is, there is no free
labour market (due to government intervention) when it comes to hiring
foreign workers in Malaysia. This is an important factor to take into
account when analyzing companies with high reliance on foreign workers,
especially operating in a country which is notorious with flip-flopping
policy changes.
Conclusion
HOMERIZ
has a very simple business model. It designs, manufactures
& exports upholstered home furniture to overseas, mostly Europe and
Japan. When analyzing companies like HOMERIZ, it is important to know The Usual Suspects,
as the lack of economy moat and catalysts makes them susceptible to
external factors. From past records, HOMERIZ shows impressive
performance, however, it was also partly due to the appreciation of USD
against MYR. In next post, we will present the past performance track of
HOMERIZ, and also present something different, that is, the real
performance of HOMERIZ over the past 3 years without taking the strong
USD in account.
References:
Hong Leong Investment Bank Research Report dated 26 January 2017
The Edge Financial Daily 26 January 2017
HOMERIZ Annual Report FY2011 to FY2017
HOMERIZ Financial Report 1QFY17
Future Trends in the World Leather and Leather Products Industry and Trade,
2010 by UNIDO
http://www.indexmundi.com
HOMERIZ (5160) HOMERITZ CORPORATION BERHAD - HOMERIZ - The Usual Suspects (B)
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