12-Month Target Price: MYR1.27
Date: May 8, 2008
Summary: Leweko is an integrated timber group with upstream forest concessions and downstream manufacturing of sawn timber, moulded timber and other timber products. The group also owns 998 hectares of oil palm plantations.
Analyst: Siti Rudziah Salikin
Highlights
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• Prices of Malaysian timber products in Europe, which is Leweko main export market, have started to pick up. However, the sustainability of the price recovery is clouded by uncertainty over the severity of the slowdown in the Eurozone economy and the housing market.
• Tight log supply will keep log prices high. Operating margins will be pressured if the weak demand from Europe is prolonged, making it difficult to pass on the cost increases to customers, in our opinion. Leweko has not resumed log harvesting at its own concessions, thus our forecasts assume its log requirements will be sourced externally.
• As timber earnings dropped, the plantation division became a significant earnings contributor in 2007, accounting for 50% of group pre-tax profit. We expect this trend to continue in 2008 on the strength of palm oil prices, which will cushion our projected lower profitability
for the timber operations. We raise our projected palm fruit output following the strong 1Q08 harvest and revised upwards our net profit for 2008 and 2009 by 3.3% and 2.5%, respectively.
Investment Risks
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• Risks to our recommendation and targe price faster-than-expected
economic growth in the Eurozone and thus a more resilient housing market, as well as higher-than-expected selling prices for timber and palm oil.
Recommendation
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• We maintain our Sell call on Leweko with an unchanged 12-month target price of MYR1.27.
• The stock currently trades at a 2008 PER of 9.6x, which we believe is about fair, given the uncertain outlook of its timber operations. From the plantation sector’s perspective, we also believe the positive earnings outlook has already been factored into the share price given that small plantation stocks currently trade at single-digit forward multiples. We have also lowered our projected dividend for 2008 to 5 sen (from 9 sen) to be in line with the company’s historical dividend payout of less than 40%.
• We continue to value the Leweko at 9x PER (which is the stock’s two year average PER) on projected 2008 earnings and add our projected dividend to arrive at the target price.
• Leweko has proposed: (i) a 1-for-20 bonus issue; and (ii) a share split of every one share (after the proposed bonus issue) of MYR1.00 each into two shares of 50 sen each. The exercise will increase Leweko’s share capital to 241.7 mln and should help to improve the share’s trading liquidity.
• From its 2006 annual report, we note that there was no mention of any corporate social responsibility (CSR) activities that may have been undertaken by the group during the year.
Business Review
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Perak-based Leweko is involved in timber and oil palm plantation businesses. Leweko owns an integrated timber operation, with both upstream forest concessions and logging businesses, and downstream timber manufacturing and processing activities. On the plantation side, Leweko is involved in upstream oil palm cultivation and selling fresh fruit bunches (FFB) in the domestic market.
The timber division was impacted by the industry downturn in 2007 Leweko’s forest concessions in Temengor Forest Reserve in Perak have about 2,000 hectares (ha) remaining. About 70% of logs harvested from its own concessions are for internal use and the rest sold in Peninsular Malaysia (logs from Peninsular Malaysia are not allowed to be exported).
In addition, Leweko has a long-term agreement with other concession holders to purchase logs from their concessions of about 2,000 ha. These will assure supply of logs for its downstream operations for the next 5-7 years.
The sawmilling, kiln-drying and timber moulding activities are carried out at Leweko’s 8.69 ha timber processing complex in Grik, Perak. Its main products are sawn timber and moulded timber, which include floor boards, decking boards, skirtings, casings and laminated woods. Initially, most of the timber products were sold locally but in the past three years, Leweko has aggressively expanded its exports. By 2007, export contribution to Leweko total revenue has grown to 41.5% or MYR50.8 mln compared with 6.7% of MYR8 mln in 2004. Europe is its major market, accounting for 83.3% of export revenue for 2007.
The timber industry, in general, performed poorly in 2007 as the real estates and construction industries (which are a good demand barometer for the timber industry) in major export markets cooled down. This was reflected in the 27.1% YoY decline in Leweko’s net profit for the year. The profit would have been much lower if not for increased earnings contribution from the plantation division.
Following the very strong first half of 2007, the markets for timber products became oversupplied. Together with the housing sector weaknesses in Japan (largely attributed to the impact of the revised Building Standards Act, which caused housing starts to plummet), the U.S. (caused by the sub-prime mortgage crisis) and Europe (due to high interest rates), prices of timber products declined throughout 2H2007. Log prices, however, were quite resilient due to limited supply.
Leweko’s logs and timber products division recorded a 74.4% YoY drop in pre-tax profit in 2007 to MYR5.5 mln. Leweko was able to grow its export revenue by 46.9% YoY in 2007 (helped by the introduction of new products, such as laminated scantlings) but domestic sales faltered along with the industry’s weakness. Margins were squeezed to a single-digit level on high log prices and fuel costs. The strengthening of MYR against US$ also contributed to the low profitability.
The oil palm businesses, on the other hand, had a good year in 2007 estates with a total area of 998 ha (of which, 961 ha are planted). The estates produced 31,322 tons of fresh fruit bunches (FFB) in 2007. Its FFB yield of 32.6 tons/ha is relatively high (the average yield for the state
of Perak was 21.2 tons/ha while that for the country was 19 tons/ha). This reflects the estates’ prime production age of between 11 and 15 years. The plantations had a good year in 2007. Due to the rise in palm oil prices, pre-tax profit for the plantation division surged 2.8x YoY to MYR9.8 mln. The average FFB selling price increased 63.3% YoY to about MYR482/ton and outweighed the 11.7% YoY rise in production costs to MYR200/ton. With lower earnings from its timber operations, plantations became a significant earnings contributor in 2007, accounting for 50% of group pre-tax profit versus 12.9% in 2006.
Earnings Outlook
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We expect the plantation division to remain a major contributor to Leweko’s earnings in 2008.
The weak demand for and prices of timber products continued into 1Q2008 while production costs have risen further.
These are expected to drag down timber earnings for the quarter.
The demand factor will determine earnings prospect going forward.
Demand for Malaysian timber products from Europe has started to pick up with marginal increases in prices.
The small recovery could be attributed to seasonal pick-ups in construction activities as the spring/summer seasons approach, in our opinion.
The sustainability of the price recovery is uncertain given the projected slowdown in the Eurozone economy.
The European Commission has reduced its 2008 economic growth forecast for the Eurozone to 1.7% and projects the growth to slow down further to 1.5% in 2009 versus the 2.6% expansion recorded in 2007.
With the European Central Bank keeping interest rates steady to curb inflationary pressure, there are downside risks to the housing market and the economic growth, in our opinion.
A slowdown in demand for timber products from Europe could put a brake on Leweko’s previously strong export growth.
Tight log supply should keep log prices high.
The heavy rainfall in Malaysia and Indonesia has slowed down logging activities and the wet weather is expected to stay at least throughout 2Q2008.
At the same time, supply of (softwood) logs from Russia is declining due to higher export taxes of 25% (effective April 2008) versus 20% previously.
The taxes will increase to 80% in January 2009.
This move, which is intended to boost the country’s domestic wood processing industry, is expected to put upward pressure on log costs given Russia’s 40% share of the global softwood log market and is viewed as a bullish factor for tropical logs.
Our concerns are: (i) decreasing log supply locally will reduce Leweko’s logs trading activities; and (ii) operating margins for its downstream timber processing operations will be under pressure if the weak demand from Europe is prolonged, making it difficult to pass on the cost increases to its customers, in our opinion. While Leweko has its own supply of logs, it has not harvested logs from its concessions since September 2007. Our forecasts assume its log requirements will be sourced from third parties until there is confirmation that a logging permit has been obtained and the in-house logging activities will resume.
In spite of our cautious view on the outlook of timber prices, we are looking at a small decline in Leweko’s 2008 profit. The group’s earnings will be supported by stronger contribution from plantations. FFB production in 1Q08 was strong, rising 24.5% YoY to 8,029 tons with better-than-expected yields. We raise our projected FBB for 2008 and 2009 by 3.2% and 2.6%, respectively. Nonetheless, given the age profile of the trees, we expect limited yield improvement from the 2007 level of 32.6 tons/ha and thus project a marginal output growth for the two years.
Earning growth be fuelled by higher FFB selling price, which we project to be 30% higher YoY in 2008 at MYR610/ton. We raise our projected net profit for 2008 by 3.3% and for 2009 by 2.5%
following the upward adjustment to plantation profit.
Valuation
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The stock currently trades at a 2008 PER of 9.6x, which we believe is about fair, in view of the uncertain outlook for its timber division. From the plantation sector’s perspective, we also believe the positive earnings outlook has already been factored into the share price given that small plantation stocks currently trade at single-digit forward multiples. We have also cut our projected dividend for 2008 to 5 sen (from 9 sen) to be in line with the company’s historical payout of less than 40%.
We continue to value Leweko at 9x PER, which is the stock’s average PER for the past two years, and assign the multiple to our projected EPS for 2008. We add our revised dividend of 5 sen per share to the stock’s intrinsic value, which is now higher at MYR1.22 due to the earnings revision, and maintain our 12-month target price of MYR1.27.
Leweko has proposed: (i) a 1-for-20 bonus issue, and (ii) a share split involving a subdivision of every one share after the proposed bonus issue of MYR1.00 each into two shares of 50 sen each. The exercise will increase Leweko’s share capital to 241.75 mln and should help to improve the share’s trading liquidity but will not have an impact on our valuation.
Recommendation and Target Price History
Date Recommendation Target Price
4-Mar-08 Sell 1.27
4-Sep-07 Buy 1.77
1-Jun-07 Buy 1.95
26-Mar-07 Buy 2.10
4-Dec-06 Hold 1.82
7-Nov-06 Hold 1.70
30-Aug-06 Buy 1.45
2-Mar-06 Buy 1.65
8-Aug-05 Buy 1.69
filed:Leweko 080508 update.pdf
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