Investment Highlights

• We maintain BUY on Dialog Group with a lower sum-of-parts based (SOP) fair value of RM3.31share (from RM3.38/share previously) after lowering profit margin assumptions, which also reflects an unchanged 3-star ESG rating. This implies a CY23F PE of 32x, 0.25 standard deviation above its 5-year average of 31x.

• We cut FY23F/FY24F earnings by 7%/3% after penciling in lower profit margins for downstream operations, which have been impacted by prolonged cost overruns from increased construction material and logistics costs.

• Dialog’s 1HFY23 core net profit (CNP) of RM259mil (excluding forex gains of RM3mil and impairment loss of RM9mil) came in below expectations at 42% of our FY23F earnings and 44% of consensus’ estimates.

• As a comparison, 1H accounted for 49%-51% of full-year net profits over the last 3 years. No interim dividend was declared, as expected.

• YoY, 1HFY23 CNP registered a flattish 1% growth, notwithstanding a larger 44% increase in revenue to RM1.51bil, mainly dragged by persistent margin contractions in the downstream engineering, construction, fabrication and plant maintenance operations amid higher project and operational costs. This more than offset the fresh earnings contributions of RM47mil from the new upstream joint venture, Pan Orient Energy (Siam).

• The depressed downstream segment’s performance caused a 24%-point decline in the Malaysian operation’s pretax margin to 22% (from 46% in 1HFY22), despite a 49% revenue growth from better project execution.

• QoQ, 2QFY23 CNP was flattish at RM129mil despite revenue rising by 12% to RM797mil, again due to the subdued downstream operations. Meanwhile, the Middle Eastern operations posted a better performance with 2QFY23 pretax profit growing by 27x QoQ to RM11mil compared to just breakeven in 1QFY22 due to significantly higher profit margins.

• Note that the weaker Middle Eastern performance in 1QFY23 was mainly due to an one-off RM7mil impairment loss on property, plant and equipment recorded by the Jubail supply base.

• Malaysian operations remain the largest contributor, accounting for 70% of 1HFY23 group pretax of RM267mil (-5% YoY), followed by Thailand (18%) and other countries (12%).

• On the other hand, Dialog has also announced the expansion in Tanjung Langsat Terminal phase 3 with the development of storage facilities for renewable products. This project marks the group’s first ever venture into storage facilities for sustainable and renewable products such as biodiesel, sustainable aviation fuel and their associated feedstock, aligned with prevailing lowcarbon intensity transitional trends.

• We also understand that the expansion entails facilities with a storage capacity of 24,000 cubic meter (cbm) connected to truck loading bays and existing marine facilities. We note that the project would likely cost RM100mil-RM130mil and generate a project IRR of 5%-8% (similar to existing terminals).

• The project is scheduled to commence construction soon and expected to be completed in the fourth quarter of 2024. Assuming a capex of RM130mil and a project IRR of 5%, we estimate that the expansion could increase both our SOP and FY25F earnings by less than 1% given the small capacity addition (as compared to the group’s current storage capacity of 5.1mil cbm).

• We still foresee a sequential recovery in downstream profit margins, albeit with a slower pace on persistently higher project costs. Meanwhile, earnings from the midstream tank terminal segment should remain stable on resilient occupancy rates and monthly spot storage rates while the upstream segment will continue to benefit from elevated oil prices of above US$80/barrel. Over the longer term, the group still has ample acreage to double its Pengerang storage capacity with a remaining 500-acre zone comprising reclaimable land and the adjoining buffer zone.

• Dialog currently trades at an attractive CY24F PE of 21x, well below its 5-year mean of 31x. We believe Dialog deserves above-peer premium valuations given its long-term recurring cash flow-generating businesses which are further underpinned by the Pengerang development’s multi-year value re-rating bonanza and low net gearing levels.

Source: AmInvest Research - 17 Feb 2023