A year since its acquisition of the Mattress Factory Outlet (MFO) chain, Malaysia’s largest latex mattress manufacturer Lee Swee Kiat Group Bhd (LSK) is not showing any signs of slowing down.
LSK has now set its sights on another furniture retail chain called Italhouse.
Such mergers and acquisitions (M&As) come as part of LSK’s aim to grow big in the local mattress retail distribution scene.
LSK managing director Datuk Eric Lee tells StarBizWeek that the acquisitions are to grow LSK’s business-to-customer (B2C) segment, which is a key focus of the group.
In particular, Lee has noticed that the “factory direct model” is a hot trend among consumers, which bodes well for LSK, in terms of greater operational efficiencies and lower economies of scale.
“You’d be surprised – I have friends who are multi-millionaires but still insist on buying factory-direct mattresses!
“Consumers are always on the lookout for great value.
“By adopting this factory direct model, LSK gets a better control of the distribution channel, cuts down on the need for the middleman, and is able to gain more market share,” he says, adding that LSK can also push more of its products through its growing network of retail stores.
Lee says that the retail push has helped LSK improve its margins and cash flow.
For example, as of May 2019, LSK had some RM10mil of orders in hand to be fulfilled, with customers having already paid the deposit for their mattresses and bedding products to be shipped.
Last week, LSK proposed to acquire the goodwill and assets of Johor-based Italhouse furniture retail showroom business, which entails seven Italhouse outlets and the ‘Italhouse’ trademark.
The effective acquisition cost of RM4.9mil will be fully-funded internally.
As of end-March 2019, LSK had net cash amounting to RM10.8mil. The company reported a net profit of RM10.25mil for its financial year ended Dec 31, 2018.
The acquisition of Italhouse comes with a net profit guarantee of RM1mil for the first year of operation.
According to CGS-CIMB, the seven Italhouse stores generated a combined revenue of RM9mil to RM10mil and a net profit of RM700,000 to RM1mil last year.
Note that Italhouse currently sells 50% to 55% of LSK’s products, and this will be increased to 90% going forward.
It is interesting to note that the Italhouse chain also opens up a new geographical segment of customers for LSK, as 10% of Italhouse’s customer base are Singaporeans and this number continues to grow.
According to Lee, Italhouse is gaining brand prominence in Singapore, with the aid of social media marketing.
LSK has one International Brands Gallery (IBG) outlet in Johor, eight in the Klang Valley and five MFO stores in Klang Valley following the acquisition of the latter. Following the acquisition of Italhouse, the group will have another 7 retail outlets.
In the long run, it is the group’s aspirations to build a strong local homegrown distribution chain of stores through market consolidation.
Lee says that the group continues to be on the lookout for more synergistic M&As.
“We are eyeing a few domestic cities or towns where we would like to grow our presence in and this includes East Malaysia.
“These M&As would have to be sensibly priced, earnings per share (EPS) accretive, and generate an annual retail revenue from RM8mil to RM10mil.
“Based on the cash flow returns from our acquisitions, it is estimated that it will take three to four years for LSK to get back its returns,” he says.
LSK manufactures two types of latex mattresses, namely, full-finished and semi-foam.
The full-finished mattresses are retailed domestically, while almost 95% of the semi-foam mattresses are exported to markets like the US, China and Europe.
In terms of revenue contribution, both segments contribute an equal half.
LSK’s comparable listed peer is King Koil bedding manufacturer OCB Bhd.
However, OCB does not own any retail stores.On a group level, LSK commands a pre-tax profit margin of 9.8%, going by its first quarter of the financial year ending December 31, 2019.
Lee estimates that the retail chain pre-tax profit margins may be much higher at 13% to 15%.
“We saw a double digit growth year-on-year in our topline last year (FY18) and expect this year’s topline to grow similarly, in tandem with higher revenue contributions and higher pre-tax profit margins from the retail segment,” he says.
While there is a slow down in new properties coming up, which could indicate less demand in bedding products and mattresses, Lee opines that there is a large market in the replacement market.
A mattress typically has a lifespan of 10 years, after which, requires replacement.
The minimum price of a king or queen sized mattress is around RM750 a piece. It is estimated that 1.5 million mattresses are changed each year alone in Malaysia.
This is based on the assumption of two persons sharing one mattress for a period of 10 years. This in turn puts the estimate size of the entire replacement market for all mattresses at a whopping RM1.13bil per year.
According to CGS-CIMB’s estimates, LSK’s current valuation is attractive at a forward price-earnings (PE) multiple of 9.2 times, which translates to a 71% discount to the research house’s overall consumer sector weighted average PE multiple of 31.9 times. LSK’s shares current trade at a historical PE of 13.3 times.
In a move to increase efficiencies, LSK has allocated an annual capital expenditure (capex) of RM3mil to increase automation and mechanisation in its production lines to reduce reliance on manual labour.
This includes investments in green technology equipment which Lee says can reduce their energy costs by 40% to 50%.
As of last year, LSK’s total production volume was 6,000 tonnes per annum.
Following the increased automation, LSK will have a production capacity of 7,000 to 7,500 tonnes per annum.
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