Wednesday, July 24, 2013

ROTARY ENGINEERING : The Worse Is Over, Looking To Better Times Ahead (Limtan)

The Worse Is Over, Looking To Better Times Ahead

Key Highlights
We are recommending a Buy on Rotary Engineering, as the company refocus their efforts in Singapore where more than 90% of their new order wins to date come from. In particular,
(1) prospects of additional contract wins (we estimate about $1bln worth of new contracts in the pipeline),
(2) expectations of earnings recovery,

(3) ability to leverage on its strong balance sheet (net cash accounts for 40% of market cap) to undertake more contracts and acquisitions,
(4) prospects for reinstatment of their dividends to 1.5-2 cents a share over the next 2 years and
(5) improved market confidence in management’s turnaround efforts as they deliver their $756mln order books, could potentially drive its share price over the next year to 78 cents (about 10x 2014 PE). Investment Merits

 Rotary (an integrated engineering design, procurement, construction and maintenance service provider to blue chip customers such as Shell, Chevron, BP, Total, Exxon Mobil, PetroChina, Oiltanking, Hin Leong, Neste Oil, Vopak Terminals, Mitsui Bispheno, Glaxo, Pfizer, Merck, Schering Plough, Saudi Aramco and Sinopec) has been in operation since 1972 and listed on SGX since 1993.

 Rotary’s 20-year track record shows that even during the Asian Financial Crisis and The Global Financial Crisis in 1997/8 and 2008/9, the company was still profitable to the tune of $7-8mln and $52-54mln respectively. And the company was still able to pay dividends amounting to 40% of profits, demonstrating strong financial discipline.

 Since the company’s listing in 1993, Rotary has generated $306mln in accumulated profits despite having reported its first ever loss of $83mln last year.

 And total dividends paid since listing in 1993 amounts to $185mln, representing approximately 60% of accumulated profits over the same period.

 As shown in Exhibit 3, Rotary’s order book peaked in 2010 at $1.3bln and has been on a consistent decline to $900mln in 2011 and $690mln in 2012. However, since early 2013, Rotary’s order book has shown signs of reversing the downtrend and in 1H ’13 alone, the company has won $402mln new contracts in Singapore, representing close to 10-fold increase compared to last year’s $42mln, bringing 1H ’13 accumulated order book to $756mln.

 More importantly, after having suffered its first ever loss of $83mln last year as a result of the $1.1bln project in Saudi Arabia (for Saudi Aramco), management has made a conscious effort to refocus their efforts on projects in Singapore, their mainstay before being hit badly in Saudi Arabia last year.

 As a result as can be seen in Exhibit 3, only 50% of their current order book is outside of Singapore compared to over 90% 2 years ago and over 80% last year.

 And the only major project that is outside of Singapore currently is the US$250mln contract to build a petroleum storage facility in the United Arab Emirates for Singapore based oil trader Concord Energy. Unlike the Saudi Arabia project which Rotary had to use Saudi Aramco’s design specification to build the terminal, Rotary is using their own proprietary design to build the storage facility for Concord Energy, hence risks of unexpected cost over-run is low.

 This suggests that there is scope for gross profit margins to revert back to their usual 15-20% range from last year’s abnormal (25%) level. This was already evident from 1Q ’13’s gross margin of 15% against 4Q ’12’s (27%) and 2012’s (25%) level. And this is despite 1Q being a seasonally low season.

 Last week, 3 of Rotary’s customers Shell, Sinopec and Total announced plans to set up new lubricant and grease manufacturing plants via a joint venture (called Singapore Lube Park ), marking a first ever such venture by the lubricant industry.

 The joint venture between the three companies will enable them to enjoy cost savings from economies of scale and synergies from the project’s shared facilities as well as enable Shell and Total to relocate from their existing facility in Woodlands which is more than 50 years old to allow them to cater to the growing demand in Southeast Asia, Middle East and Australia. The combined investment is expected to run past $500mln

 Shell which currently operates a 240,000 tpa lubricants and grease plant at Woodlands is gearing up to build a new 350,000 tpa facility in SLP and the estimated cost will run into few hundreds of millions. Total is also expected to spend a similar amount at SLP.

 This bodes well for Rotary as the company is a key supplier to both companies in the past and we believe the company is well positioned to ride on their customers’ aggressive expansion plans.

 Just last month, Petronas has called for a tender under Package 8 of the Refinery and Petrochemicals Integrated Development Project in Johor. We understand that the project is expected to run into multi-billion dollars and that Rotary has been pre-qualified to tender for this project, alongside Dialog Group Berhad.

 The company’s strong net cash position of $120mln, which represents about 40% of its current market cap puts the company in good stead to take on additional contracts (bidding for another $1bln worth of new contracts), pay dividends (we estimate to be around 40% of their profits) as well as embark on some accretive acquisitions.

Investment Risks
 With more than 7,000 employees located across Singapore, Thailand, Malaysia, Middle East, China and Australia, management said that they do not expect to increase headcount much more and would instead prefer to outsource to sub-contractors if they are able to secure more projects. The risk is if Rotary’s subcontractors are not able to meet the required standards set by their customers. But management assured that their sub-contractors have all been prequalified to meet minimum standards before they are able to service their customers. This strategy could also help to motivate their existing 7,000 employees to be up to speed compared to their sub-contractors.

 50-60% of Rotary’s cost of goods sold is made up of steel and if steel prices were to rise after they have quoted their project costs to their customers, the company would have to bear the higher costs. Fortunately, steel prices have been on a consistent decline in the past year due to the slowdown in China.

 There is still a small amount of warranty provisions that they have to do for Saudi Aramco but management do not expect this to impact their performance meaningfully going forward as they have already handed over the project to them.

 Rotary has an $82mln non-controlling deficit registered under minority interest in the company’s balance sheet as the 51% owned SATORP JV has chocked up big losses last year. While there could be risks of a write-off, management assured that this deficit will continue to remain on its balance sheet and will not need to be impaired or provided for and instead will be reduced gradually over time as the JV makes money and reduce their accumulated losses.
To date, the auditors are comfortable with this arrangement.

Valuations and Recommendations
 Based on Rotary’s current order books of $756mln on hand which management expects to be delivered over the next 2 years and assuming management is able to revert back to their historical average net margin of between 7-9% (justifiable given their order books are predominantly focused back in Singapore), we believe the company will turnaround this year to make a profit of $22mln and double its profit next year to $44mln. Forward PE of 7x is undemanding relative to its historical average of 10x. Rotary’s comparable in Malaysia Dialog Group Berhad is trading at 37x PE while its competitor in Thailand Sino Thai Engineering and Construction is trading at 21x PE. Recommend buy with a 1-year price target of 78 cents based on 10x 2014 PE (its 5-year historical average).

Source/Extract/Excerpts/来源/转贴/摘录: Limtan-Research,
Publish date: 24/07/13

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