Investment Highlights

We initiate coverage on AWC with a BUY recommendation and a target price of RM1.05. Our recommendation is premised on the group’s balanced business portfolio, which is a mix of stable and recurring-concession income, as well as high margin cash flows from its niche position in the plumbing and pneumatic waste management industry. With the renewal of the ten-year government facilities management concession and Critical Asset Refurbishment Programme (CARP) contract, on top of the acquisition of plumbing specialist, Qudotech and rainwater harvesting system provider DD Techniche (DDT), we think that AWC will achieve decent earnings growth in the foreseeable future.

With the increasing awareness for corporate and environmental sustainability, we believe there is potential growth in AWC’s green initiatives as it capitalises on its extensive skills and track record in the environmental business. AWC can also leverage on the synergy between its facilities management, engineering and environment divisions, which could further boost its earnings growth.

Moving forward, the group plans to reduce its reliance on government-related projects, while expanding its waste management and engineering operations. The focus will be on private sector projects in the healthcare and commercial sectors, which commands higher margins due to the greater amount of experience and skills needed.

We forecast AWC to register double-digit five-year net profit and revenue CAGRs of 37.6% and 16.7% to RM22.5 mln and RM314.3 mln respectively by FY18. We value the group by ascribing a target PER of 13x to its FY17 EPS of 8.0 sen, which we think is justified due to its strong earnings growth potential – as reflected in its low PEG of 0.4x for FY17.

Recommendation

We like AWC for its diverse and resilient earnings, underpinned by a balanced portfolio mix of stable and recurring revenue from the facilities division, as well as decent returns from its environmental and engineering division. Steady cash flows from concession-based facilities management contracts will ensure that AWC is well-positioned to withstand the downtrend of the cyclical engineering industry, while the group’s niche position in the plumbing and automated waste management industry will enable AWC to secure superior margins compared to its peers during the industry upcycle.

Due to AWC’s asset-light and cash rich business model, the group has a strong balance sheet with RM49.3 mln worth of unencumbered cash as of 30th June 2016. The management has also guided that about RM30.0 mln to RM40.0 mln worth of borrowings will be procured to fund the CARP project in FY17 and FY18. Still, its balance sheet strength will permit the group to expand its businesses when opportunities arise.

We also see potential in AWC’s waste management and rainwater harvesting systems which command lucrative margins despite still in their infancy stage. The increasing popularity for sustainable developments will fuel the need for green technologies and we believe that AWC has the capability to cater to the sprouting demand. Lastly, we like the synergistic advantages of its engineering division - which presents cross selling opportunities to the other divisions such as the CARP and Integrated Facilities Management (IFM) contracts from the Facilities division.

Investment Risk

Risks to our recommendation and target price include delays in project execution due to cyclical risks inherent to the construction industry, which could adversely impact the group’s margin and profitability. Failure to complete the contract works within the stipulated time frame could also result in arbitration and legal proceedings against the group, as well as tarnishing its reputation, making it difficult to secure future contracts.

The group’s engineering division faces margin compression risks due to intense competition from cheaper substitutes and the saturated local heating, ventilation & air-conditioning (HVAC) market. However, the risk is substantially reduced by AWC’s diversification into the plumbing and rainwater harvesting segment in 2015, which commands better margins. Escalating energy and utility cost, on top of higher prices of consumables, could squeeze margins of government-linked concession projects. However, this is mitigated by higher rates following the renewal of the IFM government contract, which increased to RM52.0 mln in 2016 (from RM46.0 mln) for a period of five years and to RM59.0 mln from year six onwards. Further, the facilities management fees are also subject to re-negotiation in the event of sudden cost escalations.

Higher costs (i.e: energy costs) from employing the group’s automatic waste collection system (AWCS) vs. its traditional methods could potentially deter clients. However, the management has guided that a new patented system could reduce electricity usage by approximately 80.0%.

Valuation

We arrived at AWC’s target price of RM1.05 by ascribing a PER of 13.0x to its FY17 EPS of 8.0 sen. The ascribed target PER is at a discount to its bigger competitor, UEM Edgenta due to AWC’s smaller business scale and market capitalisation. The discount is also within the 10%-25% discount accorded to smaller companies within our coverage. We opine that the target PER of 13.0x is justified given the group’s strong earnings growth potential, which is trading at PEG of 0.4x for FY17. At the target price of RM1.05, AWC will trade at implied PER of 10.1x in FY17, which is still attractive compared to its nearest competitor UEM Edgenta’s forward PER of 13.0x-17.0x. Moreover, the target price also implies a potential upside of 28.3%.

Source: M+ Online Research - 26 Sep 2016