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.
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”.
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 <Future Trends in the World Leather and Leather Products Industry and Trade> 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.
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.
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