Friday, December 24, 2010

Evergreen Fibreboard: Headwinds and more headwinds


This review should be written weeks ago, but, I keep on delaying until Q4 is going to end soon and I am reviewing Q3 figures. LOL. Since Q3 is quite a while ago, I would not touch too much on the numbers but rather focus more on the more medium term headwinds faced by the company as well as some of the recent developments.

The Q3 profits was rather bad, it is down around 45% from preceding quarters. I don't think there is a huge seasonal effects in their earnings, so comparison with preceding quarter may give us a better picture compared to a y-o-y comparison. Management gives a few reasons such as plant maintenance, increase transport cost due to ramadan, higher log costs, plant shut down for maintenance and etc. Most of these are non-recurring apart from the log costs which is inching higher.

Management also guided on higher glue cost going forward. As mentioned previously, I would not touch too much on other operating figures because it is rather long time ago and I feel that the analyst report has done a rather good job covering it. So, it would be more value adding to talk about some medium term challenges that are not that well covered by either the analysts or the media.

Overcapacity in ASEAN?

Alex Lu of the very popular nexttrade blog has touched a bit on the issue in one of his blog post here. So, are there any aggressive capacity expansion by ASEAN producers? Yes. What is the numbers we are talking about? As of today, based on the information that I have, we are looking at around 1.0585 million m3 of new capacity coming on stream on 2012 ( It takes around 1 year to set up the plant).

So, we may only get some clearer picture on margin compression on early 2012. There are only three players that are expanding but the size of their expansion is rather huge. One of them is Evergreen's former JV partner-Panel Plus with a 1000m3/day in Thailand. Panel Plus is a subsidiary of Mitr Pohl group which is one of the largest sugar producer in ASEAN. As they are under a conglomerate, Panel Plus may be a strong competitor to Evergreen as it has access to internal capital markets.

So, it will still be financially strong during the down-cycle as it can receive funding from other non-MDF division within the group. Another Thai player that is expanding is PB Rayong with a 700m3/day new plant while the most ambitious of the expansion is by VRG/Dongwha of Vietnam with a capacity of 1200m3/day. The VRG plant is the largest ever MDF plant in SEA. So, all in all, we have 1.0585 million3. These is rather huge increase as the total industry capacity in SEA currently is around 3 million, so, we are seeing about 33% new capacity coming on stream on 2012.

Some of these expansion I think is actually for CAPEX plans that being hold back during the crisis as I do not see much activity in this front during 2008 and 2009 except a small expansion from some Indonesian players. One of the more worrying trend I am seeing is the pace of the expansion worldwide, especially in China. Siempelkamp, one of the major equipment manufacturer for the MDF and PB industry is running at full capacity.Dieffenbacher, which I think is the market leader, is doing very well too by clocking in a lot of orders. In China alone, there will be at least 18 plants coming on stream in 2012 but the size of the plants is smaller than those we are seeing in SEA. The Chinese productions are mainly used to supply internal demands rather than for export, but, what I fear is that, these sort of aggressive expansion may result in Chinese productions starting to flood the export market. However, I think Chinese MDF are made using other sort of wood i.e. non-rubber log, that are perhaps more expensive. If I remember correctly (fact checking needed), they import logs from Russia. Russia, again if I remember correctly cause I sometimes mixed up between various industries, has begun to imposed taxes on its logs export a year or two ago. So, the Chinese players may have some cost disadvantaged here.

Another potential concern is that, I am observing (note: my observation may not be correct since I am not in the industry), some particleboard(PB) players are starting to add MDF into their offerings. Previously, most of the players are actually more PB-focused or are PB-only players (Evergreen is the only odd one out that focuses mostly on MDF), but, we are seeing signs of players actually shifting some of their production focus into MDF like the case of PB Rayong which I believe use to be a pure PB player rather than a MDF+PB player. So, we need to pay attention to such a shift as companies will focus more and pay more attention to their MDF division now if its contribute to a larger chunk of their revenue. This will cause potential increase in competition ahead.

On the Europe front, one of its competitor, Pfleiderer, is facing bankruptcy threat. Thus, it is closing down two of its plant but only one of those are MDF-based. Pfleiderer is actually a PB-focused player with little MDF capacity, that's why I am a bit puzzled when analyst like to use it as a peer. But, probably because there are a lack of listed engineered-wood producer to choose from. One of the reason for the Pfleiderer plant closure is that there is an overcapacity problem in Europe. So, we are seeing some overcapacity there also. On a side note, Pfleiderer closure may benefit Evergreen if they can capitalize on it to buy some parts from Pfleiderer. Evergreen management is quite savvy in buying good second hand parts to cut costs and it has bought from Pfleiderer before. But, that's a big IF and impact should not be significant.

Exchange Rate

Another potential challenges plaguing Evergreen is the exchange rate appreciation. Actually, I don't see appreciation per-se as much of a problem because everyone is facing it. Here's a chart on the year to date MYR and THB appreciation vs. USD.

(Source:Yahoo Finance)
As you can see, both countries actually appreciate at more or less the same rate. As for Euro, it depreciate by 10% vs. USD. So, MYR and THB loses around 20% advantage versus Euro. But, European producers have high cost to content with.

So, currency appreciation is not my foremost worries, it will be pass on eventually to the customer. What I am more worried is the volatility in the exchange rate. Take a look at the chart, exchange rate can move up or down by 1-2% within a week or so, which I think is a big movement. You may think 1-2% is a small issue, but, for a manufacturer with 10+ % margin, a 1-2% move may meant a 10+% decline in profits.

Let's me illustrate the situation more clearly. Imagine Evergreen hedged their USD exposure today for their sales in the next period. Then, within one week, some crazy stuff happen in Korea and everyone got scared and money flow back to US and USD appreciates by 1-2% versus MYR and THB. Then, Evergreen competitor, Panel Plus got lucky and hedged its currency exposure after the USD appreciation. Now, Panel Plus has some cost advantage that Evergreen has to match. Evergreen need to find a 1-2% efficiency gain just because Panel Plus got lucky. The volatility makes the life of the exporters much harder now. On a broader and unrelated note, it also makes comparison between exporters for example glove makers and palm oil companies much harder as you do not know which companies got lucky by hedging at the right time. So, a firm that are more profitable now may actually not be the case. But, obviously, you can take out the appreciation gain or stuff if it is reported in the detailed P&L but you need to make changes to the balance sheet too. Just makes life much harder.

Thus, appreciation is not a problem, the problem is the volatility. Life as an exporter is just getting harder and harder.

Rubber Wood Log Supply

I think on the long run, rubber log supply may be a major concern if it really run out of rubber plantation. Despite research being conducted on palm oil wood as a replacement, it is not feasible due to the low fibre content of palm oil trees. A combination is possible but not 100% palm oil wood. Evergreen previously told some RHB analysts that Malaysia has sufficient supply of rubber logs to meet 20 years of Evergreen's demand assuming no replanting. But, we need to bear in mind that Evergreen is not the only producer in Malaysia and not all of these will be sold to Evergreen. Some logs may just be left to rot.So, the sustainability of the rubber wood supply is certainly a concern but I believe the management is addressing it by looking into wood plantation. It is a long pay-back period venture that I think they will only do it if situation really become that bad. The problem I can see is that, if ,going forward, commodities prices go higher, plantation land will be more expensive too. So, the pay-back period may be getting longer and longer if the management delay getting into the project. But, this management really know their stuff, I trust them to make the correct decision.

Dawa Timber Takeover

It is a related-party transaction, so, there is always a concern for this type of deals. One of the research house actually said this takeover is overpriced. The reason. Evergreen FORWARD PE is around 6 times and the deal is done at 7-8 times HISTORICAL PE. I don't think it is logical to compare a forward multiple with a historical multiple, it is just not apple to apple comparison. Actually, if you compare Evergreen historical PE with that of the deal, the deal seems to look cheap. Another concern raise by the analyst is that it is higher that the industry multiple that is being given in Evergreen announcement. But, I have look at what is the peers are, most are lousy companies in Malaysia with some high gearing, so, it is understandable that it is 1x PE more than the industry. I am not being bias here, just stating the fact that I did not see anything fishy here. It is good that they bring the company back to Evergreen fold so that there are less issues with conflict of interest.

I will end the review here. There are actually more stuff to talk about but some are rather sensitive. I suspect one of the Evergreen competitor are actually stalking my post on Evergreen. So, I will not talk about some rather non-public and sensitive issue (it is in public domain but you need to know where to find) that may harm Evergreen competitive position. These issues may offer potential upside or downside. Google correctly and you will find it.

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