At the top of the minds of some shareholders who attended Man Wah Holdings' AGM last Saturday (July 21) was the issue of rising operating costs eroding the company’s profit margins.

Leather, which constitutes 55% of Man Wah's cost of goods, became about 25% more expensive globally in FY 07.

Product display at one of Man Wah's 154 speciality furniture stores.

Man Wah, which manufactures leather sofa sets, had to pay more for not only leather but also wood, and rental and labour. That was why its net profit rose a modest 8.8% to HK$90.7 million for FY 2007 ended March 31, while its sales surged 59% to HK$852.5 million.

Sales were boosted by Man Wah’s increasing penetration of the US market. The company now supplies to more than 20 of the 100 largest furniture retailers (as ranked by leading trade publication Furniture Today), compared to just two in FY2006. 

Hong Kong-based Man Wah expects to secure more of these retailers as new customers.

On the home front, for the PRC market, Man Wah bought back 23 CHEERS franchise stores in January 2007 from their respective franchisees. These stores are located mainly in prominent cities such as Shanghai, Hangzhou, Shenzhen and Guangzhou.

Another key development in FY 2007: Man Wah placed out 43 million new ordinary shares at 56 cents per share and used the bulk of the net proceeds of about S$23 million to fund the Phase II expansion of its Man Wah Holdings Furniture Industrial Park.

On track to annual doubling of speciality stores. Forecasts from company.

 When completed by the end of 2007, it will increase the company’s leather sofa production capacity by another 150,000 sets per annum, bringing the total production capacity to 303,000 sets per annum.

OCBC Investment Research analyst Lee Wen Ching projects that revenue will soar 44.5% to HK$1.2b in FY08 while net profit rise 22.5% to HK$111.1m.

Her estimate of the stock's fair value is 61.5 cents based on 8x blended FY08/09 price-earnings ratio.

The following are key questions asked by shareholders and answers given by management at the AGM held at Fullerton Hotel. The exchange has been edited for brevity and language.

Q What plans does Man Wah have to cope with rising labour and rental costs, and the appreciating reminbi?

A We can’t deal with rising material costs directly. As far as we know, there’s no hedging mechanism for leather prices. We will try to pass on the cost to the ultimate buyer. This will take time. There’s a time lag of about six months.

Executive chairman Wong Man Li intends to improve on Man Wah's efficiency. Picture by Sim Kih

We have increased prices for some models. New models are sold at higher prices. Costs are stabilizing now, though.

As for labour costs in China, these are creeping up, and we have to increase our efficiency.  This means moving from being labor intensive toward being capital intensive.

We are also diversifying into micro-fiber sofas.  Micro-fiber sofas generate about 20% of current sales.

Q Do you have excess inventory of leather to hedge against cost increases?

A Usually, we draw down on our leather inventory every month. If we decide to have excess inventory, we would be introducing a new risk as prices could also fall. In addition, leather comes in several colours. Some may be popular in a season but not the next.

Q How will you be affected by China’s tax reform toward a tax rate of 25% payable by foreign enterprises, up from the current 15%?

A Its impact will not be significant after consolidating the various tax structures of all our subsidiaries. 

Man Wah is buying back stores from its franchisees. Will this increase profit margins?

A The move is not necessarily to enhance margin but to serve as a role model for our business in China. Our group has experience in retail in Hong Kong.I am confident our retail segment in China will be profitable within this year.

Are all CHEERS stores profitable?

Most, if not all, CHEERS stores are profitable.

Two-thirds of Man Wah’s revenue comes from Europe and the US. How is the selling price in these two regions?

In Europe, the price is still good. In the US, we sell to large retailers and wholesalers. What price they sell to the consumer is up to them.

The chairman of Man Wah has recently invested in shares of Lorenzo. Will this affect Man Wah?

The investment is a purely personal investment and no way will it affect Man Wah.

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