Man Wah - A multi-bagger in the making?

There is a Company listed in Hong Kong called Samson Holdings (531 HK). The Company used to have the cost advantage with its factories in PRC. But unfortunately, its main customers are from USA. With the start of the US Subprime crisis, the stock price went from HK 2.50 to below a dollar now. Net profit of course tumbled from more than HK 200 million to HK 55 million. I am not implying that Man Wah will face the same fate but if Samson Holdings cannot avoid this fate, I dont see how Man Wah can.

Samson\'s Kuo Fights By Going Deeper Into U.S. Furniture Shan Huei Kuo, the founder and chairman of Asia’s largest furniture exporter, Samson Holding, has been in the furniture manufacturing business for more the two decades, working first from Taiwan and later from mainland China. The 52-year-old entrepreneur, also known as Samuel Kuo, has never flinched from making bold, so far mostly successful, career moves, including his first breakthrough, relocating his obscure production plant from central Taiwan to the industrial southern Chinese city of Dongguan back in 1991. Along with his wife, Yi-Mei Liu, or Grace Liu, Kuo later built on that modest success to become the industry leader in Asia. They then entered the branded residential furniture market in America through the creation of the Legacy Classic brand. Later, in 2001, came the acquisition of Universal Furniture, which took the company several notches up into the higher-end market segment in the United States. Last December, he earned plaudits by daring to challenge an American lawsuit alleging mainland Chinese competitors dumped their products in the United States. He won the lawsuit, and the legal victory accorded Samson tariff-free import status to the U.S. market. But the changing macroeconomic environment in China has presented Kuo and many other enterprise owners in traditional manufacturing industries with their toughest circumstances ever. Production costs are soaring in China, exacerbated by a steadily appreciating yuan, but the biggest blow this year was the scrapping of export tax rebates by Beijing for industrial lines like furniture making, textiles and plastics raw materials in July, a policy shift that is unlikely to be reversed. The impact had left deep scars on Samson’s books even before the July announcement. The company’s profit shrank by a hefty 55% to $28.9 million in the first six months of the year, down from $52 million in the similar period last year. That translates to earnings per share of 1 cent, down from 1.9 cents. Kuo’s counterstrategy presented itself in an announcement on Monday revealing his bid for Furniture Brands International (nyse: FBN - news - people ), a major customer of Samson that he considered a complementary fit with his current business. Having laid out $73.2 million in buying a 14.9% stake in the troubled, St Louis-based furniture seller, Kuo has launched a hostile bid for Furniture Brands International after being spurned in response to a merger proposal made in July. (See “ Furniture Brands Cool To H.K.’s Samson”) The announcement vowed that Samson would review its stakeholding in Furniture Brands International “on a continuing basis.” Samson’s shares, which have been listed in Hong Kong since November 2005, gained 1.15% to trade at HK$2.63 (34 cents) on midday Wednesday, after shedding nearly half of their value since July. Along with the company’s recent fortunes, Kuo’s personal wealth, which ranked him among the top 40 on Forbes’s 2007 Greater China list, is likely have suffered.

This is exactly the point I made earlier about the headwinds Man Wah were facing. While others see their US sales dropped, Man Wah were having solid growth. This is contributed by increase in their market share. Francis Lee told us during the Q1 briefing that their average selling price increase accounted for about 10% of the growth and the rest of the growth were from units sales growth. Further, according to him, Man Wah currently only have a very very small share in the US sofa market, something like 0.2% or so. With their increased production capacity, they are now in the position to take on bigger orders from these bigger retailers, bypassing the middleman wholesalers. Man Wah have all along been saying the US slow down has been good for them, because the retailers are now more keen to outsource to Asian manufacturers and for sofa product, Man Wah stands to benefit from this switch. I think we are talking about consumer slowdown rather than a great depression when nobody buy sofa anymore. It is reasonable to assume that any reduction in orders from these retailers will not be uniformly distributed. Man Wah\'s cost advantages, strong US marketing and service team, and their focus on middle market segment give them an edge over competitors like HTL. I think management track record is important here and I believe in their ability to continue their execution. But as a minority shareholder, I can only get an update at quarter end and the Q2 result will tell us whether their US strategy is still working as planned.

DAIWA report on MAN WAH this morning Performing well where others have failed Upgraded to Buy 􀂃 We have upgraded our rating on Man Wah to 1 (Buy) from 2 (Outperform), due largely to the stock’s valuation. Target price lowered 􀂃 We have lowered our six-month target price from S$0.59 to S$0.29. The lower target price reflects the change from a peer valuation to DCF, as other furniture stocks have performed poorly and our DCF valuation assumes a WACC of 18%. Nice bottom-up idea 􀂃 In our opinion, Man Wah is a solid bottom-up idea, as we think the company has superb products at very attractive prices and superior distribution into the US. Its North American sales more than doubled on a year-on-year basis for April-June 2008, evidence of its successful operations, in our view.

In our opinion, the secret to Man Wah’s success is a combination of scale, quality and distribution. SCALE Man Wah’s main manufacturing site is located in Dayawan, east of Shenzhen. This large factory is located in an industrial business park, built with the intention of easy and large capacity expansion. The company completed its Phase II expansion at the site recently, taking annual capacity production to a very large 430,000 sets per year. How big is 430,000 sets? This site’s capacity alone is more than 10x larger than Lorenzo International’s (Lorenzo) (LOREN SP, S$0.08, 2) CY07 capacity of 36,400 sets/year. When we visited Man Wah’s Dayawan site, we were impressed by the size and scale of the operations. The Dayawan site employs thousands of workers, some making foam the width of a city bus, others doing nothing but nailgunning wooden frames together in rapid succession. It also houses around 2,000 sewing machines. QUALITY Quality is subjective, but we believe we understand the details of Man Wah’s product offering. In our opinion, Man Wah’s products are high-quality, usually using top-class leather (ie, not splits, backs or synthetic leather), hardwood (ie, not fibreboard), Leggett & Platt’s (LEG US, US$21.22, Not rated) steel components, and full high-quality foam (ie, not chopped foam, non-foam fill or low-quality foam that deforms quickly). In our opinion, Man Wah’s product-quality finish is better than most competing products of a similar price, and as good as many products that are more expensive. Those investors who live in Hong Kong and the PRC can see the quality themselves at the Morewell stores in Hong Kong, and the Cheers stores in the PRC. How price competitive is Man Wah? A typical mid-range Man Wah set is sold ex-factory for about US$600-700. Assuming a 100% retail mark-up, this means an entire sofa set (ie, sofa, love seat and chair) can be bought retail for US$1,200-1,400. In China, a typical set retails for Rmb8,000-18,000. Those who have shopped for furniture might know how hard it is to find a fabric sofa for that price – let alone a whole set upholstered in high-quality leather.

DISTRIBUTION In 2007, Man Wah invested in its own on-the-ground sales distribution channels in North America, run by experienced North American managers. This contrasts with other sofa manufacturers that might use Asia-based salesmen filling orders for wholesale agents, who then sell on the products to retailers. How important is this sales channel integration? The North American market is enormous. While Man Wah has huge capacity, some individual US speciality furniture retailers also sell a large amount of sofa sets. For example, Rooms to Go sells about 202,000 sets per year, American Signature sells 180,000 sets per year,and Berkshire Hathaway Furniture sells about 154,000 sets per year. This means a small percentage gain in market share can mean huge orders for Man Wah. If Man Wah’s North American revenue is rising quickly and the overall market is shrinking, this means that it is gaining market share. From whom is it gaining market share? While the US imports significant quantities of PRC-made sofas, we believe that competition is keenest for low-end and mid-range fabric sofas. We believe that the high-end leather sofa market is still dominated by the Italians and the Americans. Thus, we think that there is still significant market share available for Man Wah to gain due to China’s cost advantages. According to Man Wah’s management, it has a share of less than one percentage point of the US sofa market. This is not to say that Man Wah is not having any problems. The company’s 1Q FY09 European sales fell by 23.6%, due largely to weakness in the UK. We do not think that Man Wah can gain significant market share over the next few years in Europe, due to the very fragmented nature of the market, in terms of physical size and styling. That is to say, we believe it is currently too expensive/difficult for Man Wah to set up its own distribution channels in the fragmented/heterogeneous European sofa market, whereas the homogenous US market is conducive to owning the distribution channel. Therefore, we expect European sales to suffer should the European economies worsen.