Can You Sleep Soundly If You Invest In Lee Swee Kiat Group Berhad?

Lee Swee Kiat Group Berhad (“LSK” or “the Group”) was established in 1975 by its founder Mr Lee Swee Kiat. From a furniture trading company, it has grown to one of the most extensive mattress manufacturers in South East Asia with one stop production lines including natural latex foam, polyurethane foam and various spring productions.

As at 5 November 2019, the Group has a market capitalisation of approximately RM107.40 million. In this article, we will take a closer look at the business, management and financial aspects of the Group, to gauge its suitability as an investment.  

Business Overview

LSK is primarily involved in manufacturing various types of bedding products, specialising in the production of 100% natural latex mattresses. Besides mattresses, the Group also produces semi-finished products, such as latex foam, which are exported to international mattress brands. Bedding products make up more than 95% of its total turnover. More than 50% of LSK’s products are exported.

In 1996, LSK was recognised in the Malaysia Book of Records as Malaysia’ largest natural latex bedding manufacturer in terms of production volume. The Group owns two manufacturing facilities that occupy a total land area of 440,000 square feet in Klang, Selangor. The table below shows the Group’s growth in latex production over FY2016 – FY2018.

Source: LSK’s annual reports

Besides manufacturing latex mattresses, LSK distributes a portfolio of popular mattress brand in Malaysia and other countries. For example, LSK is an exclusive distributor of Tempur in Malaysia, a mattress brand owned by Tempur Sealy International Inc., the world’s largest bedding provider. Along with distribution agreements for other popular international brands, LSK has grown its own portfolio of mattress brands to 40 registered trademarks.  

(LSK’s brands, Source: Group’s website)

In the local market, LSK sells its products directly to customers through a growing network of retail stores, which includes IBG, Mattress Factory Outlet and Italhouse. With its own outlets, LSK is able to retail its products directly to consumers instead of going through distributors or third party furniture sellers. This allows LSK’s products to be sold at more affordable prices giving the absence of distributor mark-ups.    

Comments:

• LSK adopts an asset-light business model and focuses on being a niche player in high value-added 100% natural latex bedding. Being based in Malaysia, the Group has a competitive advantage in terms of its strategic location where rubber supply is ample. Beside Malaysia being the fourth largest natural latex producer in the world, surrounding countries such as Thailand and Vietnam are all major producers of natural rubber.

• LSK aims to build brand equity through its portfolio of brands under management. With its diverse range of bedding products, the Group aims to meet the varying needs of middle to high range customer segments. By focusing on middle to premium range, the Group looks to avoid price wars in the low-cost segment.

• In the short term, LSK’s sales may be affected if there is weaker consumer spending. For example, 2015 and 2016 were extremely challenging years domestically for LSK as local demand for furniture dried up as consumers held back their spending on durables, post implementation of the Goods and Services Tax (GST) from April 2015. The further depreciation of the Malaysian Ringgit against the US Dollar also affected their distribution of imported brands as imported goods cost more for the local consumers.
  
  Over the long term, demand for mattress products is expected to be driven by i) shorter replacement cycle for mattresses, ii) higher incomes leading to better consumer affordability, and iii) greater awareness of the importance of mattresses and quality sleep.

• Any sharp increase in natural latex price in a short period of time will have a negative impact on the Group’s performance since natural latex is its main manufacturing material. While LSK has the ability to pass on the hike in raw material prices if latex prices stay at elevated levels for an extended period of time, the price increases could affect demand for their products.

• LSK is actively mechanising its operations to reduce reliance on labour. The Group plans to improve the efficiency of its production lines by introducing robotic arms and more energy-efficient machinery, which should mitigate the rising labour cost.  

Management

Note: Dato Eric Lee and Mr Vincent Lee are brothers and they are sons of Mr Lee Ah Bah @ Lee Swee Kiat and Madam Tan Kuin Luan.

(Source: 2018 annual report)

Comments: Since 1975, LSK continues to be a founder-led and managed business. We like the fact that the directors are substantial shareholders, and trust that they would be motivated to ensure the continued success of the Group. Further, the strategic principles adopted by LSK in its major business decision making give us greater confidence that minority shareholders’ interest are protected.

(Source: 2018 annual report)

An interesting point to note is that as at 31 December 2018, LSK holds 4,687,900 treasury shares out its 167,815,704 issued and paid-up ordinary shares. Such treasury shares are held at a carrying amount of RM1,840,054. As the average purchase price of each treasury share is RM0.39, the treasury shares are considered “in the money” since they were purchased below the current share price of RM0.64. In this case, LSK’s management has shown proper usage of share buy-backs by acquiring its own shares when the Group’s share price was undervalued.      

Financials

(Source: 2018 annual report)

Comments:

We find many positives with the LSK’s past 5 years’ performance:

• The Group has achieved revenue and profit after tax compound annual growth rate (“CAGR”) of 8.14% and 25.72% respectively. In fact, the net profit margin of the Group has improved significantly from 5.61% in FY2014 to 10.24% in FY2018, demonstrating management’s commitment to control costs.

• LSK’s financial position has also improved from a net debt position of approximately RM2.85 million in FY2014 to a net cash position of RM11.34 million. This can be attributed to a healthy cash flow position.

• The Group has recorded commendable return on equity ratios over the 5 years, providing that management is efficient in using and allocating investor capital. LSK has also introduced a formal dividend policy to set aside a minimum of 30% of profit after tax for dividend payment.

Conclusion

(Source: Google Finance)

With a closing share price of RM0.64 as at 5 November 2019, LSK is trading at a price of earnings (PE) ratio of 10.19, with an indicative yield of 2.34%. At this valuation, I personally feel that the stock is relatively fairly valued.

Notwithstanding the above, a report by Zion Market Research forecasted that the global mattress market was valued at around USD 27 billion in 2017 and is expected to reach approximately USD 43 billion in 2024, growing at a CAGR of slightly above 6.5% between 2018 and 2024. Therefore, investors with a positive view on the prospects on the bedding industry should put LSK on their watch list.  

In addition, we believe near term catalysts for the Group include:-

• Focusing on cost efficiencies through implementation of more automation in its manufacturing process;
• The Group is looking to invest RM8 million in a fully automated latex semi-foam production line in 2020; and
• LSK is searching for Merger & Acquisition opportunities to grow its presence in the domestic bedding retail market. It plans to acquire business-to-consumer bedding retailers, to have more direct sales channels to market its products to consumers directly.  

Therefore, I am quite optimistic about the future of Lee Swee Kiat Group Berhad and definitively adding this company into my personal Watchlist.

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