Summary
PH is a home and office furniture manufacturer with 67% and 23% of sales coming from USA and Canada respectively. On Earnings Power Value basis and assuming all cash on hand is used to pay 2 years worth of fixed costs (assuming that's how long till the Covid situation is under control), current valuation assumes it will suffer a 20% permanent loss in revenue into perpetuity. On net asset value basis, you could buy PH with its lands at cost value and all other PPE written down to zero.
Notable: Pangolin Asia Fund acquired 4 mil shares by conversion of warrants in August 2019, bringing their shareholding to 5.8%. Pangolin is a value fund who also engages with management of its investees, so I hope to see some of that come through to PH.
The elephant (or bear) in the room is clearly the current economic situation: with US joblessness at record highs and offices needed and desired less than ever (people now realise they can work from home), who is going to want to buy furniture?
Disclaimer: My family may have positions in any company mentioned in this article.
Introduction
This is investment idea #3 because I already have reviewed two prior to writing this (Magni-Tech and Malaysian Airports). They, along with an intro to EPV, can be found here: https://www.linkedin.com/in/christopher-tay-89477b8a/
I would deeply appreciate any input and feedback e.g. What did you think was lacking? Did I miss anything out?
Let's dig into PH.
How PH makes money
PH makes furniture for retailers in USA and Canada for them to sell on. According to Statista, the relevant furniture market for PH made USD150 billion in sales in 2019.
PH has factories in Malaysia and Vietnam. According to Affin Hwang, these are the top 3 customers by country of manufacture.
Housing starts were their strongest in 13 years in December 2019, but with the current economic destruction in the US and globally, I don't know when people will start putting furniture in these houses.
Further questions I do not have the answer to:
When will people start thinking about buying furniture again?
If people stay and work at home more, do they want to buy more furniture?
Will millennials and future generations live in a way that requires less furniture/ is more minimalist?
What I do know is that Buffett via Berkshire Hathaway owns several home/ furniture companies: Nebraska Furniture Mart, Jordan’s Furniture, Star Furniture, Shaw Industries and R.C. Willey. He also bought into RH, an upscale furniture and home retailer in November 2019. I also know that PH is net cash and has enough cash to spend on 2 year's worth of fixed costs (estimated as all costs less COGS for FY19).
Economic moat
Whilst its expertise and years of experience is beneficial to PH, I don't think it has a moat. It endures intense competition from operators in China and Vietnam. It's EBIT margin is thin at less than 10%.
Valuation
Thus, the only reason why PH is interesting is its valuation. Using good ole EPV, my valuation is as below:
Sensitivity table
After factoring in 2 years' worth of fixed costs and assuming PH only starts earning 2 years down the road, the current price today implies a 23% permanent drop in revenue at 8% cost of capital. On net asset value basis, we could buy PH with its lands at cost value and all other PPE written down to zero.
We only want to invest if heads we win, tails we don't lose so much. Given that the EPV gives no value to growth, PH looks like if it makes about RM585 million in revenue, there is a 35% upside.
Another thing that befuddles me is why Latitude trades at such a higher EV/EBIT compared to its peers.
Conclusion
PH looks interesting only due to its valuation. There is the margin of safety from the no-growth assumption and 'zero revenue for two years' assumption. However, PH has no moat and it is uncertain whether switching costs with its main suppliers is high. If it is high, it may mean that it would be difficult for PH to look for new customers.
There was a time, during the market meltdown, PH traded as low as RM0.75! If only I did this before today.
Any feedback and input on this is welcome!
P.S.
Looks like the market also thinks PH will use up all its cash until things recover. Prior to the realization that things were going to shit, PH was trading at EV/EBIT 3.6.
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