OCBC: Rotary Engineering - Priming David for Goliath’s world

Rotary Engineering: Priming David for Goliath’s world

By Kelly Chia Wed, 5 Aug 2009, 14:58:01 SGT

Summary: Rotary Engineering (Rotary) reported 2Q09 this morning with revenue of S$164.2m (+22% YoY, +24.5% QoQ) and bottomline of S$13m (+11%YoY, +200% QoQ).

2Q results were inline with our expectations with a final wind-down of its previous tranche of projects.

We do not expect Rotary to require significant debt financing as its projects are cash flow positive.

While M&As are an option with a net cash horde of S$110m, we think that Rotary will explore JVs/alliances first to evaluate the partner and market it intends to penetrate into.

We opine that soon-to-be listed competitor, PEC Group (Not Rated), would not currently pose a threat to Rotary’s market in the Middle East.

With the anticipated surge in earnings, we have doubled our dividend forecasts upwards for FY10F to 4 S cents (prev. 2 S cents).

With better clarity on SATORP, more regional-based projects slated to come online and improved equity risk appetite, we have re-pegged our valuation to 12x FY10F EPS (prev. 8x). Iterate BUY for Rotary with a fair value of S$1.26 (prev. S$0.81).

Better sequential performance.

Rotary Engineering (Rotary) posted 2Q09 results with revenue of S$164.2m (+22% YoY, +24.5% QoQ) and bottomline of S$13m (+11%YoY, +200% QoQ); 2Q results were inline with our bottomline estimates but a final phase wind-down of its previous tranche of projects bettered our topline forecasts.

Gross margins were at the lower end of its guided 18-22% range as revenue are recognised from current projects that were secured in 2008’s “cost conscious environment”.Good balance sheet. Historically, Rotary’s projects have largely been self-financing, even for its previous mega project of the Universal Terminal.

As such, we do not expect Rotary to require additional significant amounts of debt except for trade financing for intermittent gaps.

While M&As are an option with a net cash horde of S$110m, we think that Rotary will explore JVs/alliances first to evaluate the partner and market it intends to penetrate into.Competitor listing. PEC Group (Not Rated) – soon to be listed on the SGX mainboard (priced at 4x FY09F PER) - intends to have a fabrication facility in the Middle East by 2010 to compete for projects.

Currently, we think that PEC’s presence should not pose a significant challenge until it firmly establishes its working relationship with its JV partners and facility.

(prev. 2 S cents). This brings the yield to 3.5%, a respectable return for an industrial-based company.

Calculated expansion pays off; Maintain BUY. Rotary arrived at this stage with much foresight in its manpower training and calculated Middle East investment.

We have adjusted our estimates to cater to the US$745m contract value (prev. US$700m) along with increased variation orders for its current tranche of projects.

Our previous concerns on the dilutive effects of the JV have been alleviated with half of the US$745m to be performed directly by Rotary instead of its JV.

Accretion of SATORP earnings is now modelled over 3.5 years (prev. 4 years). With better clarity on SATORP, more regional-based projects slated to come online and improved equity risk appetite, we have re-pegged our valuation to 12x FY10F EPS (prev. 8x).

Iterate BUY for Rotary with a fair value of S$1.26 (prev. S$0.81).