- We maintain our HOLD call on Boustead Heavy Industries Corp (BHIC) with an unchanged sum-of-parts- (SOP) based fair value of RM2.40/share. This implies an FY14F PE of 16x – near our FBM KLCI target of 16.5x.

- After extensive negotiations, BHIC’s 21%-owned Boustead Naval Shipyard (BNS) has finally signed a formal contract to design, construct, equip, install, commission, integrate, trial test and deliver six Second Generation Patrol Vessels with Littoral Combat Ship (LCS) capability for the Royal Malaysian Navy for RM9bil.

- Since BNS was given a conditional award for this contract back in December 2011, this means that it took the group 2½ years to complete negotiations on contractual terms with the government. In the meantime, the group has not been able to recognise any revenue or earnings contribution from this contract.

- As the group is already involved in designing and engineering work for the LCS over the past 2 years, we expect BHIC’s 3QFY14 earnings to register a significant QoQ surge as the group barely broke even in 1QFY14.

- While detailed negotiations are to be expected for such a huge military contract, we are not impressed by the length of time required by the group to reach finalisation. Even in the case of a much smaller RM15mil contract, awarded back in March 2013, to provide maintenance, repair and supply of spare parts for the Gun Oerlikon 35mm and Radar Skyguard to the Malaysian Army, BHIC needed over a year to finalise the agreement.

- Besides these contracts, there are other military contracts that are still pending the formalisation of terms. These include the Defence Ministry’s contract, awarded back in December 2013, to manufacture and supply of Airbus A400M mission systems, spares and logistics for an initial 140 shipsets, from Cassidian Airborne Solutions GmbH.

- Hence, we remain cautious on the group’s longer term earnings quality due to:- 1) extensive delays in formalising official contracts for projects already awarded,; 2) unresolved execution delays for both military and commercial projects; and 3) margin compression for increasingly competitive tenders for oil & gas projects.

- The stock currently trades at a fully-valued FY14F PE of 17x – 5% above our FBM KLCI target. 

Source: AmeSecurities