Furniture Stock with Strong Growth Potential

NOTICE : Kim Eng Securities (Thailand) Public Company Limited (KIM ENG) has participated as an underwriter in relation to the public offering of Fancy wood industries Public Company Ltd. This document was prepared by KIM ENG independently of the Company. In particular, the forecasts, opinions and expectations expressed in this document are entirely those of KIM ENG and are given as part of its normal research activity and not as an underwriter of the share offering or as an agent of the Company, any other syndicate member, or any other person. While all reasonable care has been taken to ensure that the facts stated herein are accurate and that the opinions and expectations contained in this document are fair and reasonable, neither KIM ENG nor the Company has verified the information given in this document. Accordingly, no representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information contained in this document. No one at KIM ENG, the Company or any other person, or any of their respective directors, officers or employees, accepts any liability for any direct or consequential loss arising from any use of this document or its contents or otherwise arising in connection therewith.

Fancy is Thailand’s largest rubber wood furniture exporter, supplying OEM chairs and tables to the US, Canadian and UK markets. Its products are sold through large retail chains, such as J.C. Penney, Sam’s Club, Walmart, Kmart and Basset Furniture. FANCY has a cost advantage being able to source abundant rubber wood from Southern Thailand. In 1H03, FANCY will start supplying bedroom furniture to existing clients.

Due to strong demand, FANCY’s chair and table factory in Samut Prakarn province is currently operating at full capacity. The company is doubling its rubber wood-processing factory in Surat Thani province from 400,000 cubic feet per month to 800,000 in 2003, which will be used to supply its new bedroom furniture line at this factory.

Even with a slight net cash position, FANCY will be funding the cost of its Bt855mn expansion project with the proceeds of its recent public offering of 19mn shares at Bt45 each. After the PO, FANCY’s total outstanding shares were increased from 75mn shares to 94mn and its free float from 6% to 25%. This should, to some extent, alleviate FANCY’s major drawback of relatively low trading volume. The new shares will begin trading on February 19, 2003.

We are forecasting FANCY’s earnings to rise 25% this year to Bt620mn due to full capacity utilisation of its existing plants. Even after the dilution of the PO, EPS should decline only slightly to Bt6.6/share. Next year, we forecast EPS to expand 28.7% to Bt8.49/share. We believe that FANCY is very attractive at the current 2003 PER ratio of 7.58x with dividend yield of 12%, which is paid on a quarterly basis. Given its earnings growth potential and quality of earnings, we believe the stock should trade at around 10.0x 2003 EPS or Bt66 per share.

Profile

Fancy Wood Industries Co.,Ltd (FANCY) was established in 1970 as a joint venture between Thai and Taiwanese investors to produce household furniture made of oak, pradoo and teak wood. In 1985, however, the company started to shift its furniture to exclusively rubber wood. In 1999, FANCY established Fancy Wood International Co.,Ltd (FWI) to supply its major raw materials, rubber wood and laminated rubber wood, with a capacity of 400,000 cubic feet per month.

Public offering

FANCY successfully offered 19mn shares to the public on February 10-11 at Bt45mn per share. FANCY will spend the Bt855mn proceeds on two new projects and working capital. The 19mn newly issue shares will result in a 25% dilution of EPS. However, since the new expansion projects begin operation in 1Q03 and will immediately contribute to earnings, we expect to see only a slight deterioration in EPS from an estimated Bt6.62 in 2002 to Bt6.60 this year.

After the PO, FANCY’s total outstanding shares were increased from 75mn shares to 94mn and its free float from 6% to 25%. This should, to some extent, alleviate FANCY’s major drawback of relatively low trading volume. The new shares will begin trading on February 19.

Figure 2: FANCY shareholder breakdown

Source : SET and Fancy Wood

Furniture business

FANCY’s major products are wood chairs and tables accounting for 48% and 45% of total sales, respectively. Rubber and laminated wood and other types of furniture, such as wood bookcases, contribute 7% to sales.

Figure 3: FANCY sales breakdown

Source : Fancy Wood

Exports account for approximately 95-97% of FANCY’s rubber wood furniture sales. Of total exports, the US accounts for around 80%, while the remaining 20% are exported to Canada and Europe. In the US and Canada, FANCY’s products are largely sold through well-known retailers such as J.C. Penny, Walmart and SAM’s Club.

Figure 4: FANCY’s revenue breakdown by market

Source : Fancy Wood

Manufacturing capacity

FANCY’s chair and table factory is located in Samut Prakarn province. Rubber wood raw materials are supplied by FANCY’s wholly-owned subsidiary Fancy Wood International Co.,Ltd (FWI). The furniture factory in Samut Prakarn consumes about 400,000 cubic feet of rubber wood per month and produces chairs and table furniture at a rate of 250-260 containers per month.

FWI’s rubber wood and laminated rubber wood processing factory is located in Surat Thani province, near Thailand’s rubber plantations and the major source of raw materials. With 80 band saw machines and 88 kiln dry rooms, the factory currently produces 400,000 cubic feet of processed rubber wood per month.

Figure 5: FANCY production profile

Source : Fancy Wood

Capacity expansion and new products

FANCY is in the process of expanding FWI’s production capacity of rubber wood from 400,000 cubic feet per month to 800,000 cubic feet per month by installing an additional 60 kiln dry rooms and processing equipment in 1Q03.

The company is also in the process of opening a new furniture-manufacturing factory at Surat Thani. At the end of 1Q03, the plant will begin commercial production of bedroom furniture. We expect the new bedroom furniture product line will immediately increase FANCY’s total sales by 30% since FANCY has already taken orders for this new product from the company’s existing client base since last year.

The new bedroom furniture plant will have capacity of 550 containers per month. However, since bedroom furniture tends to be more bulky than knocked-down table sets or chairs, the sales value per container will be around US$10,000-11,000, compared to table and chair container value of US$13,000-15,000.

Figure 6: FANCY’s new investment projects

Source : Fancy Wood

Figure 7: FANCY’s expanded manufacturing production capacity

Source : Fancy Wood

Furniture market conditions

One of the major concerns is that FANCY is expanding furniture production at a time that the outlook for the US economy is still uncertain. However, recent US statistics on furniture sales and furniture imports continue to indicate that the market continues to expand at a satisfactory rate.

Sales of furniture and home furnishings by US retail stores are estimated to have increased by 4.2% in 2002. Meanwhile, total imports of furniture and household goods in the first eleven months of 2002 grew by 14% yoy. FANCY’s own order book reflects this, as the company’s factories were operating at full capacity last year at around 400,000 cubic feet per month.

Figure 8: Estimated advance monthly retail sales

Source : U.S. Census Bureau * Advance estimates

Figure 9: Furniture imports into the US

Source : U.S. Census Bureau

Preliminary indications are that furniture demand in the US will continue to expand this year based on current US Census Bureau private housing numbers. In 2002, private residential building permits increased 5.5%, housing starts by 6.4% and housing completions by 5.1%. In December 2002, the number of permits rose 10.5%, starts by 15.9%, but completions were down 1.3% yoy.

We also believe that FANCY has major competitive advantages, which will allow the company to maintain sales even if the market were to slow. FANCY’s major advantage is that its factories are located in Thailand, which is the world’s largest rubber producer. Secondly rubber wood is relatively cheap in Thailand since rubber trees need to be replaced every 5-7 years. Thirdly, consumers tend to prefer solid wood furniture rather than particleboard or MDF furniture produced by FANCY’s major export competitors in China.

Quality raw material supply has been a key factor in margin improvement

The rubber wood accounts for around 50% of FANCY’s cost of goods sold, while other materials represent about 13%. After establishing FWI in 1999 to supply rubber wood, FANCY’s gross margins have dramatically improved from 17% in 1999 to 31% in 9M02. FWI not only helped improve FANCY’s overall margins, but also has given the company more control over product quality.

This year, however, gross margins should be down slightly to around 30% as the company begins to depreciate its new factory.

Figure 10: FANCY sales and margins

Source: FANCY

2002 earnings performance
We expect FANCY’s 2002 sales to increase 27% from Bt1,516mn to Bt1,935mn on the back of an increase in production utilisation to 100%. Since FANCY tends to maintain relatively stable gross margins of around 31%, we are expecting a corresponding 31.9% increase in full-year earnings to Bt496mn.

Figure 11: FANCY quarterly earnings projections

	Net Profit				Normalised Net Profit
	2001	2002	% Chg		2001	2002	% Chg
Q1	56	128	129.7%	Q1	50	129	160.0%
Q2	84	125	49.5%	Q2	81	132	63.9%
Q3	107	120	11.7%	Q3	97	113	16.7%
Q4E	130	123	-4.8%	Q4E	129	126	-1.9%
Year	376	496	31.9%	Year	356	501	40.6%

FANCY’s fiscal position is healthy. As of 3Q02, the company’s debt-to-equity ratio stood at just is 0.37x. FANCY does not have any long-term debt.

This year, we are projecting FANCY to achieve sales growth of 29% to Bt2,497mn. Since the Samut Prakarn factory will continue to operate at full capacity, the major earnings driver will be the new bedroom furniture plant in Surat Thani. We conservatively assume that the plant will produce 130 containers per month in 2Q03 and increase to 200-250 containers per month in the third and fourth quarters. Given the higher overhead cost and slight margin contraction, we are forecasting a 25% increase in 2002 net profit to Bt620mn.

FANCY is expected to achieve an EPS this year of Bt6.6, since the projected earnings growth of 25% is almost completely offset by 25% share dilution after the public offering.

Although FANCY has the policy to pay dividend 50-60% of net profit, we expect FANCY to pay dividends of nearly 100% of EPS. In the first three of 2002, the company has already paid out dividends of Bt4.5. In 2003, we expect dividends of Bt6, representing a dividend yield of 12% at the current share price.

Fair value

Currently, FANCY shares look particularly attractive trading on a 2003 PER of 7.58x, EV/EBITDA of 5.99x and dividend yield of 12.00%. We believe the shares will be re-rated higher as trading volume improves after the public offering and the company’s earnings prospects improve with the production from its new furniture plant.

Given the company’s growth prospects, we believe the stock should trade up to a PER of 10x, or Bt66 per share.