Maxtral Industry Bhd - 2008

MARC has affirmed its short-term MARC-2ID and long-term AID ratings on wood-based product manufacturer Maxtral Industry Berhad’s (Maxtral) RM80 million Al-Bai Bithaman Ajil Islamic Debt Securities (BaIDS) and RM20 million Murabahah Underwritten Notes/Murabahah Medium Term Notes (MUNIF/MMTN) facilities. The outlook on the rating has been revised to negative from stable to reflect increased pressure on Maxtral’s liquidity as a result of upcoming debt maturities and uncertainties regarding its sustainable free cash flow trends in light of softening market conditions in most end markets for wood-based products.

The affirmed ratings incorporate the satisfactory operating performance of Maxtral’s integrated timber operations, its moderately leveraged capital structure, tempered by its modest financial flexibility, the cyclicality of the timber industry and weather-induced fluctuations in log supply. Maxtral’s venture into non-timber related businesses, i.e. plantation and property development will expose the company to additional market and operational risks.
 
Sabah-based Maxtral is involved in the manufacture of veneer, plywood and moulded products, and commercial log trading. In FY2007, the group’s revenue almost halved to RM112.1 million following reduced log supplies from its logging area in Kuamut, Sabah, caused by unfavourable weather condition and declining commercially-viable log quantities in the area. Maxtral’s revenue generation was also impacted by the softening demand from its export markets including Taiwan, US and Korea that translated into a 53.3% lower export revenue of RM52.3 million in FY2007 (FY2006: RM112.0 million). While Maxtral has aggressively implemented cost reduction measures and increased its sales of higher-margin products which to shore-up its operating profit margin, the improving trend in margins was reversed in FY2008 (unaudited) as a result of rising operating costs.

The group has now addressed its log supply constraints by entering into long-term supply agreements with a concession holder and a Sabah-based timber company in 3QFY2007 and 1QFY2008 respectively. Nevertheless, the group’s operating performance is likely to be pressured in 2009, driven by weaker demand as a result of global  economic  slowdown  as  well  as  rising  overhead  costs  in I ts timber operations. In FY2007, Maxtral diversified into property development through acquisition of 25,575 square feet commercial land located within the prime area of Kuala Lumpur. Its planned luxury-condominium project on the land is still pending approval from the authorities. Maxtral is currently clearing its 2,950 acres agricultural land in Ranau, Sabah, which will be replanted with oil palm plantations within a two to three year time frame.

In FY2007, Maxtral recorded negative free cash flow (FCF) of RM58.1 million, primarily as a result of capital outlay to secure log supplies in its second logging area as well as capital investment on its timber complex and land acquisitions. Nevertheless, its cash flow protection measures improved slightly in FY2008 as reflected by its positive FCF and net cash flow from operation (CFO) with CFO interest cover improving to 2.45 times (x) in tandem with a reduction in log supply advances. Maxtral’s unaudited debt-to-equity and finance service coverage ratio, which stood at 0.52x and 2.52x respectively as of end-December 2008 are well within the financial covenants under the issuances.

Maxtral has managed to meet its first principal repayment of RM20 million of the BaIDS due on April 13, 2009. The funds were mainly from its external sales. The next repayment of RM20 million, due in April 2010, is likely to be met partly from projected sales proceeds and additional equity injection.

The negative outlook incorporates uncertainties regarding its sustainable internal cash flow generation and highlights the possibility of a downward rating action in the event of failure to improve its liquidity position vis-à-vis the scheduled repayment over the next 12 months.

Major Rating Factors

          Strengths  

• Integrated timber operations;
• Operational flexibility in log extraction and plywood manufacture; and
• Moderately leveraged capital structure puts less pressure on cash flow protection measures during unfavourable demand fundamental.
  
  Challenges/Risks 
   
• Deteriorating profitability affected by lower demand for its processed wood products;
• Increased operational risks in certain logging areas could cause disruption in log supply;
• Cyclical and highly competitive timber industry;
• Execution risk arising from new ventures into palm oil plantation and construction; and
• Liquidity risk and thin cash flow coverage could heightened concern based on lumpy scheduled repayment starting April 2009.