The Magic Formula for some furniture companies kcchongnz

The Magic Formula for some furniture companies
“The secret to successful investing is to figure out the value of something and then-pay a lot less”           
Joel Greenblatt


Exactly ten months ago, I did an analysis of some furniture design and making companies listed in Bursa as shown in the appended link here:
http://klse.i3investor.com/blogs/stock_pick_challenge_2013_2h/40360.jsp
Since then, all these furniture companies have been doing quite well. Most of them have their revenue and profit increased for the last one year with the exception of Tafi Industries which was still making losses for its last quarter. Tafi is hence omitted from this update analysis.
The share price of those furniture companies have also increased by huge amount ranging from 37% of Homeritz, to 101% of Hevea. For the same period, the broad market only increased by 2%. Table 1 below shows the increase of share price of those companies in the last 10 months.
Table 1: Share price comparison of some furniture companies

Company	Homeriz	Lii Hen	Latitude	Eurospan	Hevea	Poh Huat
Price 8/12/13	0.575	1.65	1.81	0.510	0.950	0.910
Price now 9/9/14	0.790	2.48	3.44	0.995	1.91	1.40
Gain	37%	50%	90%	95%	101%	54%

As all the share prices of these furniture companies have increased substantially in just 10 months, are they expensive now, and if not which one is a better buy? Before that let us carry out an analysis of their latest trailing twelve month (ttm) financial statements ended 30^th June 2014.
Profitability and operation efficiencies
Table 2 in the appendix shows the ttm revenue and profits of the furniture companies. Latitude has the highest revenue and net profit of RM651m and RM64.3m respectively for ttm ended 30^th June 2014, whereas Eurospan has the lowest revenue and net profit of RM65m and RM5.7m respectively.
As shown in Table 3 in the appendix, in terms of net profit margin (NPM), Homeritz excels by a wide margin of 19.7%, the only one with double digit net profit margin, followed by Latitude from far behind at 9.9%. Poh Huat has the lowest net profit margin at just 5.5%.
The high net profit margin of Homeritz boost up its return on assets (ROA) to a high 0f 22.8%, although its asset turnover (AT) is one of the lowest at 1.2, and its return of equity (ROE) to 26.6%, even with the lowest leverage at just 1.2. Homeritz thus has plenty of room to further enhance its ROE if it can increase its sale and add on some leverage.
The other two companies which have very good financial performance are Latitude and Lii Hen, both with ROA and ROE above 10% and 15% respectively. The return on invested capital (ROIC) of Homeritz is particularly extraordinary at 45.7%. The rest are also doing very well with their ROA and ROE of more than 7.5% and 10% respectively. All the companies earn double digit ROIC, the first portion of Greenblatt’s Magic Formula. Yes, all the furniture companies here were doing well for the last financial years with all margins and efficiencies outperform the industry benchmarks, thanks to the resilient local and overseas furniture market.
Figure 1 below shows the comparisons of margins and efficiencies of the six furniture companies. It is pretty obvious which is the one outperforming the rest with a wide margin. Homeritz, with its value added design input, is clearly a much more efficient furniture companies among the whole lot.


Ranking in operation efficiencies and management effectiveness
With the size of the companies, their past year profitability and efficiencies, I would rank the companies from the best according to the following order:

1. Homeritz
2. Latitude
3. Lii Hen
4. Hevea
5. Poh Huat
6. Eurospan

I rank Eurospan arbitrary at the bottom due to its smallish operations and hence more risky due to volatility of earnings. But does the market agree with me with its valuation?
Market Valuation
Table 4 in the Appendix shows the market valuations of the furniture companies. It is surprisingly that Eurospan and Poh Huat were given highest PE ratio of 7.8 as shown as they are the less efficient as shown in Figure 1 above. They were also with the lowest earnings yield (Ebit/EV) of about 15%, the second component of Greenblatt’s magic Formula. The rest are all having earnings yield of well above 20%. It is rather bewildering that the higher margin and more efficient companies were accorded with lower PE ratio and higher earnings yield which logically should be the other way round. For example, Homeritz with the highest ROIC of 45.7% is selling at the second cheapest at an earnings yield of 25%, whereas Hevea with the  lowest ROIC of 11.4%, is trading at a lower EY of 16%, the second highest price of them all.
On the other hand, market valuation based on book value shows Homeritz is “correctly” priced at the highest price-to-book value of 1.8, and Hevea the lowest at 0.7 as shown in Table 4.
Conclusions
All the furniture companies mentioned here are doing very well in their business with high ROE and ROIC. All of them are also selling at very good price with earnings yield of more than 15%. If I were to choose which furniture companies here to invest, I will certainly choose Homeritz with extraordinary efficiency of 45.7%, far ahead of others, and at the same time, trading at one of the most attractive earnings yield (ebit/EV) of 25%. The next one which I will also invest is Latitude which also has a very high efficiency of ROIC at 25.5%, and selling at a low PE ratio of 6.1 and an earnings yield of 24%.
I have done exactly that. What about you?

KC Chong (10^th September 2014)

Appendix

Table 2: Revenue and net profit of furniture companies

Company	Homeriz	Lii Hen	Latitude	Eurospan	Hevea	Poh Huat
Revenue	129913	356528	651025	65195	403007	372180
Operating profit	29781	33112	75540	6906	37816	25212
Net profit	25601	23783	64333	5674	30866	20382
EPS, sen	11.0	39.6	56.6	12.8	32.6	18.3

Table 3: Margin, operation efficiency and management effectiveness

Company	Homeriz	Lii Hen	Latitude	Eurospan	Hevea	Poh Huat	Benchmark
Net profit margin	19.7%	6.7%	9.9%	8.7%	7.7%	5.5%	6.4%
Asset turnover	1.2	1.5	1.4	1.1	1.0	1.5	0.9
ROA	22.8%	10.0%	13.5%	9.2%	7.5%	8.0%	5.6%
Leverage	1.2	1.6	1.5	1.3	1.6	1.5
ROE	26.6%	15.5%	20.9%	11.9%	12.3%	12.2%	11.6%
ROIC	45.7%	18.9%	25.5%	19.8%	11.4%	14.3%	7.0%

Table 4: Market Valuations of furniture companies

Company	Homeriz	Lii Hen	Latitude	Eurospan	Hevea	Poh Huat	Benchmark
Price	0.790	2.480	3.440	0.995	1.910	1.400
PE	7.2	6.3	6.1	7.8	5.9	7.7	16.4
Price-to-book	1.8	1.0	1.1	0.9	0.7	1.0	1.6
Price-to-sales	1.2	0.4	0.5	0.7	0.4	0.4	1.1
EY= Ebit/EV	25%	28%	24%	24%	16%	15%