Benefiting from recovery in office/home furnishing market

• We are initiating coverage on Modernform Group (MODERN) with a BUY recommendation, as we like the company’s growth prospects, strong financial position, attractive valuation and high dividend yield. MODERN should be a major beneficiary of a recovery in office and residential furnishing demand due to the recent pick up in both new office take-up and new housing sales. MODERN is the leader in office furniture market with a 30% share. The company has also captured a leading position in the upper end of the residential furnishing market and is currently benefiting from supply contracts to the large housing developers, like Land and Houses.

• MODERN’s four furniture factories are currently operating at a utilisation rate of 65-70%. The company also has 12 office furniture showrooms and 12 residential furniture showrooms. Last year, the company closed two non-profitable showrooms in order to improve margins. Due to this cost cutting measures and improving utilisation rate on growth in sales, we expect MODERN’s margins to improve from 31% last year to 33-34% this year.

• We forecast MODERN to report a 2002 net profit of Bt101mn including the impairment loss of Bt66mn. Excluding this extra item, we expect the company to achieve a normalised profit of Bt167mn up 7% yoy. We are projecting earnings of Bt188mn this year and Bt208mn in 2004.

• We expect MODERN to pay a dividend of Bt2 from its 2002 operations, which represents an attractive dividend yield of 8.4% at the current share price. With virtually no debt, strong cash flow and no major new investment project, we believe the company can pay a dividend of at least Bt2 for the next three years.

• Currently, MODERN shares look attractively priced on 2003 PER of 10.1x and EV/EBITDA of 6.9x. Based on our DCF model, we estimate MODERN’s fair value at Bt31 per share, representing a potential 30.8% upside from the current share price.

Figure 1 : Financial ratio

Leading furniture manufacturer and distributor in Thailand

Modernform Group (MODERN) is a leading manufacturer and distributor of office and residential furniture in Thailand. The company has licenses to produce Steelcase and Kitchen brands and has developed its own brand names, such as Moflex and Klasse, for the premium and high end of the furniture market.

Besides MODERN’s furniture business, which contributes around 76% of total revenues, the company also has a packaging business undertaken by 60%-owned Thai Plaspac Co. Ltd. and rental income from 100%-owned Modernform Tower Co. Ltd.

Figure 2 : Revenue breakdown by business

MODERN currently has four factories with an utilisation rate of 65-70%. The upholstery plant is operating at 80% of capacity while the wood product plant is at 65%. MODERN can easily further expand production capacity by adding a second shift to solve any bottleneck problems.

All of MODERN’s sales are made to order. The company only mass produces on certain standard products where demand is very predictable. Therefore, the company does not tend to stock finished goods inventory. Typically, the company completes an order in approximately 2-3 weeks.

Raw materials account for roughly 50% of the company’s cost structure. The major raw material is particleboard and MDF (Medium Density Fiber), which is supplied locally. The company uses domestic sources for around 72% of its raw material requirements. Therefore, foreign exchange fluctuations do not significantly affect the company’s cost structure.

The company has 12 office furniture showrooms and 12 residential furniture showrooms. Last year, the company closed two non-profitable showrooms in order to improve margins. The company could also add new showrooms in good locations. Almost all of the showrooms are stand alone since rental space within shopping centers tend to be too expensive.

The company tends to achieve average gross margins on showroom sales of 40-45%. However, including overhead costs, contract sales are a little more profitable. Overall, 70% of MODERN’s furniture sales are on contract terms and 30% from showrooms.

Approximately 90% of MODERN’s sales are in Bangkok and nearby provinces with the remaining 10% exported. Of the exports, roughly one-third is sent to Japan and the rest to India, Singapore, UAE, Hong Kong, the Philippines, Malaysia and Vietnam.

According to management, the key driver of office furniture sales is new office uptake, while new housing projects drive residential furniture sales. Last year, we estimate that MODERN’s sales grew only 2.3% to Bt1,825mn. Sales in the first half of 2002 slow, but began to pick up in the third and fourth quarters. Given orders so far this year, sales will still be good in 1Q03. The management has set a full-year 2003 sales growth target of 15%. However, MODERN believes that a stronger growth rate can be achieved in 2004, as new homebuyers begin to furnish their homes.

Office furniture market

MODERN is the leader in the office furniture market with a 30% share of the Bt3-4bn market. The company has two primary brands “Steelcase” and “Moflex” positioned in the premium and high-to-middle markets, respectively. Steelcase offers high margins, but volume sales are not big. Currently, Steelcase accounts for 15% of office furniture sales and Moflex around 60-65%. Last year, MODERN launched a new brand named “SOHO” (Smart Office Home Office) to take target the casual furniture market.

Mass market sales, which include government purchases and student desks, represent the remaining 20% of sales. However, mass market sales tend to offer low margins due to a competitive bidding process.

Office furniture sales are largely driven by new take-up of office buildings. New office take-up peaked in 1995 and MODERN’s sales peaked the following year. During the Asian economic crisis, total office take-up shrank in both 1998 and 1999, leading to the sharp fall in MODERN’s office furniture sales.

From the year 2000, we have seen a gradual improvement in demand for new office space of approximately 300,000-400,000 sq m per annum. Demand has been particularly strong for grade A office space in the CBD (central business district) due to the growth of the services sector. Assuming demand continues to rise in the range of 300,000-400,000 sq m. in 2003 and 2004, the vacancy rate for grade A space should decline to only about 12% by the end of next year.

Figure 3: MODERN sales versus take-up of new office space

Source: MODERN, Richard Ellis and Kim Eng estimates

Residential furniture market

MODERN has captured approximately 5% of the residential furniture market that is valued at around Bt20bn per annum. MODERN aims for the top end of the market, while the two leaders in the industry SB Furniture and Index Furniture target more of the mass market in the medium-to-low end.

MODERN has furniture supply contracts with leading property developers, such as Land and Houses (LH), Sansiri (SIRI) and Noble Development (NOBLE). These contracts are largely kitchen furniture, which are typically installed at the completion of new housing units. Currently, MODERN has a contract value of Bt100-150mn with LH and around Bt30-40mn with SIRI.

According to MODERN’s management, homebuyers tend to gradually purchase the remaining housing furniture, such as bedroom and living room furniture, over the next one or two years. MODERN’s management, therefore, believes that the pick up in demand for new housing units over the last six months will translate into particularly strong growth in demand for residential furniture beginning next year.

We don’t see a direct correlation between MODERN’s sales and increase in total housing units registered in the Bangkok Metropolitan Area since the total number of units are largely skewed towards the lower end of the market. We believe pre-sales and pre-built sales of the largest developer, Land and Houses, serves as the best gauge for future growth in demand for MODERN’s residential furniture sales.

Figure 4: MODERN’s sales versus Land & Houses sales

Source: MODERN, LH and Kim Eng estimates 

Financial

MODERN has strong cash flow and a very solid financial position. We estimate that the company had a gearing ratio of only 0.04x at the end of last year with a current ratio of around 2.6x.

We expect MODERN to generate operating cash flow of Bt252mn or Bt3.15/share, up 62% yoy. The company currently has a retained profit of Bt423mn or Bt5.30/share and equity of Bt1,916mn or Bt24/share. For these reasons, MODERN can afford to maintain a high dividend payout ratio.

Earnings forecast

In the first nine months of 2002, MODERN reported net profit of Bt44mn, down 59% yoy due to a one-time impairment loss of Bt66mn on its investment in PICNIC. However, this was a non-cash item and the company can still benefit from tax savings of around Bt15mn in 2003.

We forecast the company will report 4Q02 normalised profit of Bt57mn, up 28% qoq and 18% yoy. This is mainly due to the high season furniture sales and improvement in gross margin.

For whole year, we expect MODERN to announce 2002 normalised profit of Bt167mn, an increase 7% yoy. Including the impairment loss of Bt66mn, the company should announce a net profit of roughly Bt101mn.

Using rather conservative earnings assumptions, we are forecasting MODERN’s normalised profit will grow by 13% and 11% for the years 2003 and 2004, respectively. The key earnings driver will be margin improvement and growth in sales due to the recovery in the housing and office markets.

Figure 5 : Earnings forecast

Dividend

Officially, MODERN has a policy to pay dividends of 60% of net profit. However, the company paid out 70% from 2000 earnings and 75% from 2001 earnings. As the impairment loss in 2002 was a non-cash item, we are expecting a Bt2 dividend, or 159% of 2002 EPS of Bt1.26. Actually, we estimate the company generated cash flow per share last year of Bt3.15. The Bt2 dividend would represent a very attractive of 8.4% at the current share price.

Given the company’s earnings growth and no need for additional capital expenditure, we believe that MODERN will be able to maintain a Bt2 dividend over the next several years.

Valuation

Currently, MODERN shares look attractively priced on a 2003 PER of 10.1x and EV/EBITDA of 6.9x. However, we prefer to use a discount cash flow (DCF) method to value MODERN’s shares due to the company’s predictable cash flow with a sustainable growth. We assume the company has a terminal growth rate of 3% and WACC of 9%. Based on these assumptions, the company’s fair value is Bt31 per share, which would put the stock on a reasonable 14x PER.

Sensitivity analysis

A sensitivity analysis between WACC and terminal growth shows that if we fix WACC at 9% and let the terminal growth change, we still get a fair value higher than MODERN’s current share price. Also, if we fix the terminal growth at a rate of 3% and maintain WACC below 12%, the stock also appears to be undervalued.

Figure 6 : Sensitivity analysis