✨ Poh Huat Berhad (7088.KL)
One of the best MD&A sections you will ever read in a small-cap ASEAN company's annual report... and a superior value stock at a great share price!
Poh Huat is a furniture manufacturer with manufacturing operations based in Malaysia and Vietnam - but is largely exposed to the North American furniture market, where it sells the bulk of its furniture products to.
Poh Huat’s management provides amazingly detailed MD&A in their annual reports - with robust and thoughtful updates about their business activity for the financial year (including macroeconomics discussion).
The company has decent ROI metrics, despite the presence of a hugely outsized cash balance - which presently stands at 36% of their current market capitalization.
The Poh Huat investor is exposed to 5 main types of risks - Demand risks, Supply risks, Pandemic-related risks, Customer Concetration risk and Forex risk.
However, there remains negligible going concern risk to Poh Huat given its large cash balances. The company would need to experience zero FCF for 2.5 years before bankrutpcy starts becoming a real possibility - which is a highly unlikely development.
At a normalized PE ratio of 7x and a normalized ex-cash PE ratio of only 4x , Poh Huat’s shares are undervalued today despite the absence of visible growth catalysts. The investment thesis boils down to buying their shares today and waiting for the next furniture sector upcycle - all while being paid an approximately 5% dividend yield to wait for it to materialize; and there is huge built-in upside optionality by virtue of its large cash holdings.
Poh Huat Resources Holdings Berhad (‘Poh Huat’) is a Malaysian furniture manufacturer which mainly exports its finished products to North America - i.e. USA (76%) and Canada (20%). They have two manufacturing operations in ASEAN - one in Malaysia, and one in Vietnam. The Malaysian manufacturing base represents their legacy operations; while their Vietnamese manufacturing base is a relatively new setup in comparison.
If you’re a frequent reader of this blog, you’ll know that I’ve assigned high praise to the Poh Huat’s MD&A in their annual reports before. Despite being a Malaysian small-cap stock - where the status quo is to reprint a boilerplate MD&A template (since “nobody will read it anyway”) - Poh Huat’s MD&A discussion is extremely thoughful and informative. I would even go so far as to describe it as being more robust than the MD&A section of some large-cap stocks - which are not immune to utilizing boilerplate MD&A templates either.
In fact, the only small-cap Malaysian stock I know which has equally robust MD&A disclosures in their annual reports is Hibiscus Petroleum Berhad - which I’ve whinged fancifully over in the past for similar reasons. (their MD&A even has a macro section!) If this has tickled your fancy, do take a look at my previous Hibiscus reports by clicking the links below:
Obviously, I’m not recommending this stock simply on the strength of their MD&A disclosures. However, at the very least, it shows that management cares. Despite being a small-cap stock whose MD&A section “nobody will read”, they still go the extra mile to ensure that those who do “bother to read” it get the business updates they are looking for. Also, as I’ve mentioned, their MD&A disclosures are among the most robust in the Malaysian small-cap universe - click the link below to download their Annual Report 2020 and see for yourself:
Anyway, enough praising of their MD&A section. Let’s get into it to see why it’s even so great to begin with.
Business Profile from Poh Huat’s MD&A
In this section, we shall be exploring the MD&A section from Poh Huat’s FY20 annual report. The reason why we’re discussing their FY20 annual report rather than their FY21 annual report is simple - the latter hasn’t been published yet. However, I look forward to providing an update on their FY21 MD&A when it eventually comes out in a couple months time.
In the meantime, let us bask in the glory of their FY20 MD&A section for now. The relevant sections that we shall be discussing here are as follows:
(The above links which jump to the relevant chapters will only work in the desktop version of Google Chrome. If you’re using a different browser, please scroll to the relevant chapters below.)
Products & Markets
As mentioned above, Poh Huat mainly manufactures furniture for its US and Canadian customers - who are typically furniture middleman distributors, or even the furniture brands themselves. In this sense, Poh Huat mainly plays the role of an OEM - although it does ply a tiny amount of its sales under its own homegrown brands. 76% of Poh Huat’s total revenue comes from their US customers, while 20% of it comes from their Canadian customers. Broadly speaking, they manufacture 2 types of furniture - office furniture and home furniture.
Poh Huat’s furniture tends to occupy the upper-middle tier of furniture brands - think Ikea or Wayfair. They’re not the cheap bottom-of-the-barrel stuff typically associated with imports from China; nor are they the gleaming countertops or marble tables which look at home in a Kardashian’s house. Rather, they’re the kind of furniture which looks really decent on the outside, and would make you proud to invite a guest into your home - but whose interiors look relatively unappealing if you actually open a cabinet door. And given the highly commoditized nature of the furniture market, you can expect them to be decently-priced too.
Poh Huat does have its own B2C furniture brands, but the significant bulk of their furniture sales are made to other brands - i.e. Poh Huat is mostly an OEM. This is true for both their home and office furniture segments - where they mostly make products to be sold to major furniture importers/distributors, who will then resell them to the actual furniture brands. As a manufacturer, this naturally places Poh Huat quite high up on the supply chain.
However, Poh Huat’s MD&A section does make mention of management collaborating closely with their final furniture brand customers, in order to decide on manufacturing strategy. By this, I mean that Poh Huat isn’t simply bulk producing bog-standard cabinets to be sold to the mass market regardless of customer demographic. Given their relatively high positioning in the North American furniture market, their target customers (e.g. office workers, first-time homebuyers) tend to be quite fashion- or trend-conscious and want furniture which keeps up with the times.
In this sense, Poh Huat actually does R&D by sending their people over to their distributor customers - to identify furniture trends in the North American market in order to help the latter better serve their own customers. For instance, in their FY20 annual report, they discussed recognizing the increasing WFH trend amongst North American furniture customers and adapted some of their furniture to become more “modular and flexible to accommodate shared workspace and home-offices”. They also acknowledged the increasing shift towards e-commerce furniture sales spurred by the pandemic - which drove higher sales share amongst millenials, who tend to be “more price-sensitive than other age cohorts”. Their MD&A also mentioned taking notice of customer purchases adopting sustainability trends, with customers now “paying more attention to eco-friendly and sustainable sourcing and manufacturing furniture”. I’ve provided screenshots of some excerpts from their MD&A below:
This type of market research is reminiscent of Toyota’s now legendary Total Quality Management (TQM) manufacturing strategy, where Toyota worked hand-in-hand with their distributor customers in Western markets to map out manufacturing strategy - as compared to the then-traditional status quo of manufacturing automobiles in a geographical vacuum. Obviously, Toyota’s TQM involved far more than just that; but Poh Huat’s top-down market-focused approach which maps strategy beginning from the customer still draws similar comparisons to the former.
This is in stark contrast to the lower-tier furniture manufacturing model, which still largely adopts the bottom-up spray-and-pray method of industrializing a furniture assembly line with cost as a strategic priority; and simply relying on hope that enough customers will find value in the finished product to buy it in sufficient quantities.
By doing so, Poh Huat is able to cater their manufacturing capacity towards a forward-looking strategy that is aligned with their end-customers, and which takes into consideration the pain points of their middleman customers. For instance, they might have recognized in 2020 that customers were shifting their furniture purchasing habits towards e-commerce - and subsequently cater more manufacturing capacity towards Ikea-style flat-packed furniture which is self-assembled at home; rather than bulky fully-assembled pieces which might be more appropriately sold to a furniture showroom.
This is the beauty of having a fully fleshed-out MD&A in your annual report. By disclosing such granular business strategy to your passive investors, it provides them with a higher level of perspective and assurance about the possible range of movement within your business, and helps align your business with like-minded investors. In Poh Huat’s case, it informs potential shareholders that a well-thought-out process exists behind their corporate strategy - and that Poh Huat isn’t necessarily swimming in the same waters as their China furniture manufacturer brethren; who tend to occupy the lower-tier highly commoditized space where economies of scale rule supreme. If nothing else, it at least informs investors that some form of process moat actually exists - in the absence of which Poh Huat could never possibly be competitive against their larger furniture manufacturing competitors overseas.
While we can clearly see that Poh Huat pays special attention to the demand-side of their business, they wouldn’t be a furniture manufacturer without the opposing supply side of the equation.
Poh Huat has two manufacturing bases - one in Malaysia, and one in Vietnam. They manufacture panel based products in Malaysia, where processes are more machine-driven and hence more automated . Wood based furniture which involves more elaborate manual-driven fabrication and finishing processes are manufactured in Vietnam, where they enjoy labor availability and cost advantages.
We can see from their segmental revenues above that Poh Huat’s export activity is pretty much evenly split between their Malaysian and Vietnamese exports over time. Now I’ll be the first to admit that I’m not an expert in consumer furniture tastes, and I can’t really tell if there are any competitive advantages between selling panel-based furniture vs wood-based furniture. But as we shall see later, Poh Huat’s ROA is also pretty evenly split between Malaysia and towards Vietnam - indicating that the economics of manufacturing handcrafted mahagony oak tables is pretty similar as compared to flat-packed particle board cabinets.
In their MD&A, Poh Huat describes their corporate objective as:
“Enhancing shareholder value by exploring opportunities vis-a-vis enterprise risk appetite in a sustainable manner and providing a sustainable return on investment for our shareholders”.
Similarly to what we saw with BJCORP’s management discussion, the ability of Poh Huat’s management to articulate the importance of attaining a “sustainable return on investment” tells me that they have a good head on their shoulders. In an era of growth at all costs, this focus on attaining not just a healthy ROI but one achieved in a sustainable manner tells us that management understands that adequate profit has to be achieved as a function of yield on invested capital (rather than in spite of it) - and that proper risk management plays an indispensable role in the maximization of long-term profits.
Poh Huat’s management also highlights 3 key success factors in their business strategy:
High Quality Innovative Products
Excellent Customer Services
I’ve already discussed some of these in the above paragraphs - but this entire section is a blast to read, and I’d highly recommend going through it yourself for the nitty-gritty details. Regardless, these customer-focused efforts have apparently borne fruit, as demonstrated in the following encouraging paragraph found in their MD&A:
Risk Factors Associated With Our Business
As many of you should be familiar with, most corporate discussion of business risk tend to be boilerplate templates. You can tell because they are basically the same copy & paste mirror of the same risk template from seemingly the same 3rd party outsourced investor relations firm - where every single conceivable risk that could ever potentially happen is included in their risk disclosures - regardless of whether it is actually relevant to the particular business or not.
This results in such risk disclosures being irresponsibly long to the point of most investors not even bothering to read them - which defeats the purpose of having risk disclosures to begin with. This type of negligent “everything but the kitchen sink” treatment of risk disclosure simply results in the actual risks being hidden in plain sight - which is an excellent way of washing your hands off of them if you actually have risks to hide.
In contrast, Poh Huat’s discussion of the relevant risk factors which affect their business in their MD&A is thoughtful and relevant. Allow me to share with you one of the beginning paragraphs of the risk section in their MD&A (emphasis mine):
The furniture industry is particularly sensitive to cyclical variations in the general economy and to uncertainty regarding future economic prospects of the countries in which we export or sell to. Economic downturns in these countries could affect consumer spending habits by decreasing the overall demand for home furnishings. Changes in interest rates, consumer confidence, new housing starts, existing home sales, the availability of consumer credit and broader national or geopolitical factors have particularly significant effects on our business.
Financial difficulties experienced by our customers, including distributors, could result in lower orders, shipment delays and inventory issues and thereafter risks to accounts receivable including delays in collection and greater bad debt expense. A downturn of these countries could also materially and adversely affect our ability to take advantage of market opportunities.
As you can observe, the risk factors being discussed here bear evidence of extremely thorough and thoughtful rumination about the relevant business factors that are actually in play - rather than just regurgitating the previous year’s template. It is this kind of disclosure which engenders confidence in management, by their simple act of providing evidence that these risks have actually been considered. Maybe it’s just me - but I don’t think it’s that difficult to take just one a day off a year to put pen to paper and communicate to your shareholders what they really deserve to know about their business.
Once again, I’d invite you to read their excellent discussion of risks in their MD&A yourself. The points below are an overview of that discussion:
Adverse economic and industry conditions could have a negative impact on our business.
The markets in which we operate are highly competitive and we may not be successful in winning new business.
Increases in the market prices of raw materials may negatively affect our profitability.
Disruptions in the supply of raw materials and components could adversely affect our manufacturing operations.
Increasing competition for production and skilled workers could adversely affect our business.
We are subject to changes in foreign government regulations and in the political, social and economic climates of the countries from which we source our products.
Changes in the value of the US Dollar compared to the currencies for the countries from which we operate could adversely affect our sales, earnings and liquidity.
Each of the above headline risks have several paragraphs worth of discussion, and are an absolute joy to read for the risk-focused value investor. If stock market regulators really want to engender market development, ensuring thoughful disclosure of risk factors in the MD&A is one excellent place they could start.
Overview of the Business Environment
In this section of the MD&A, management provides a backward-looking review about how their industry had fared over FY20 - as well as identifying several options for their forward-looking corporate strategy. Once again, the discussion here is thoughtful and robust.
Management identified several notable trends and observations in the business environment of Poh Huat during FY20. I’ve summarized them as below:
Global furniture trade
Rapid urbanisation, rising income and standard of living (particularly in emerging economies) - leading to increased disposable income, growing purchasing power, and higher willingess to invest in home improvements and decorations.
Higher demand for branded home furniture coupled with rising spending capacity of consumers.
China’s continued dominance in global furniture imports (40%), with the USA in second place (12%); China also took first place in furniture exports, with Germany ranking second.
US Furniture Market (Poh Huat’s main market)
More than 90% of exports go to the USA and Canada; hence the wellbeing of these countries’ economies are key to Poh Huat’s performance.
Leading macroeconomic indicators include new home sales, mortgage rates, business confidence, employment and household income.
The US-China trade war and COVID-19 movement restrictions led to fundamental changes in both the sourcing and retailing of household and furniture sectors.
Traditionally, US consumers care more about quality and durability than price levels when purchasing furniture. Consumers expect wall decor and wood furniture to have a longer comparative lifespan. However, millennials who are more price-sensitive than other age cohorts are now entering the market, leading to demographic changes in the market with younger generations becoming customers and online stores becoming the fastest-growing channel.
Trends in the US Furniture Market:
The Growth of Online Furniture Sales
More Flexible Workspaces and Working From Homes - this trend gave rise to stronger demand for home and home-office furniture; manufacturers have responded by designing and producing furniture that are modular and flexible to accommodate shared workspaces and home-offices.
Increased interest in Sustainability and Eco-friendly furniture
As you can see, even my bullet point summary of this section of their MD&A provides a decently comprehensive picture of the opportunities and challenged faced by Poh Huat - in light of the COVID-19 pandemic and its impact on the US furniture sector.
Notably, management even incorporates a macroeconomic lens in their discussion of the factors affecting the US economy (highlighted in bold above). I can tell you from personal experience of reading dozens of annual reports that almost no other Malaysian small-cap stock discusses macroeconomics in their MD&A - even large-caps barely scrape the surface of it. In contrast, Poh Huat’s management provide a thoughtful discussion which furnishes a highly comprehensive paradigm of their business environment - of which US macro plays a significant role. The other industry observations that were discussed also do a good job of providing an all-rounded overview of the wider industry developments in the US furniture market.
Business Operations Review
As in the previous section, I shall provide a summary of this section of their MD&A - where management provides a backward-looking review about how FY20 worked out for them. For the full details, I’d recommend going through the full discussion yourself.
Poh Huat entered FY20 in an external business environment characterized by the US-China trade war, which introduced significant structural changes for China-based furniture manufacturers which exported to the USA. This global supply chain realignment ended up benefiting Vietnamese furniture exporters (and to a lesser extent those in Malaysia), contributing to YoY sales growth of 5.6% during the first four months of FY20.
However, this uptake of orders was unexpectedly interrupted by the onset of the pandemic in the USA in March 2020. The resulting economic decline led to a drastic drop in US store traffic and store closures, with many of Poh Huat’s customers being forced to reschedule orders for shipments during 2Q20.
Subsequently, the Malaysian government also introduced lockdowns to curb the spread of the virus - which effectively halved the workforce at Poh Huat’s Malaysian manufacturing operations. While their manufacturing operations in Vietnam weren’t subjected to the same vigour of lockdowns during 2020, the sharp decline in orders from their US customers and the uncertainties of prolonged disruption of manufacturing activities also led to scaled-down operations and some shedding of the workforce there.
However, the US Federal Reserve’s rapid dovish response to the pandemic led to an unexpectedly swift recovery in US furniture sales by May 2020 - largely driven by pent-up demand from the previous two months of uncertainty and the shift to WFH by US furniture consumers. By June 2020, US importers’ inventory had drawn down significantly following 2 months of halts in imports - leading to a backlog of orders as Poh Huat struggled to fulfill orders which had been previously cancelled and rescheduled. This led to Poh Huat seeing an increase in orders for the remainder of FY20.
Eventually, both their Malaysian and Vietnamese manufacturing operations recovered to pre-pandemic levels of activity - with labor productivity recovering gradually, as workers adjusted to the new social distancing and health precautions. Similarly, raw material supplies normalized following some delay in imported materials and adjustments to sourcing plans. Poh Huat’s management also implemented RM 7 million worth of planned investment in automation and upgrading of manufacturing processes - to improve operating efficiency and reduce their reliance on manual labor, thus mitigating rising future labor costs.
The shift in demographics and increasing trend towards e-commerce sales amongst their US customers also dictated new functional and design requirements for their furniture design - with Poh Huat working closely with their key US customers to develop and launch new ranges of furniture which incorporated requirements for more efficient warehousing and distribution; as well as “consumer friendliness” considerations for ready-to-assemble products. Many companies had also put more effort towards their online retail stores, by adding benefits for consumers who shop online - such as free delivery and installation, and even same-day pickup. Poh Huat responded by rationalizing their product mix to accommodate for more e-commerce savvy customers.
As we can see, the robustness of discussion in this section of Poh Huat’s MD&A far surpasses the typical boilerplate template that we usually find in the MD&A section of their small-cap counterparts - and even some much larger companies. In an investor environment where simply repurposing last year’s MD&A template with the latest year’s figures has become the norm, reading a heartfelt update by management with a genuine intent to inform is a breath of fresh air.
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Financial Analysis of Poh Huat’s FY21 Performance
Finally, we come to Poh Huat’s FY21 results! As we can see from the tables above, Poh Huat has some pretty interesting financial statistics. If you’re a free subscriber reading this and would like to gain more clarity into the figures above, do sign up for a free 30-day trial by clicking the image below to read the rest of this report!
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