We like Dialog for its consistent earnings growth profile (9%-22%), rising ROE (12.4%-14.2%), and recurring income business model. Re-rating catalysts, in our view, would rest on earnings growth from PT2SB, upstream segment amidst rising oil prices as well as news flow of Pengerang Phase 3 initial investment. Aplenty of future growth is available in Pengerang, including capacity expansion on buffer land, EPCC & plant maintenance job opportunities and potential venture into petrochemical space. Thus, we initiate coverage on Dialog with a BUY rating at a TP of RM3.76 (+18% upside), based on SOTP valuation.

Resilient business model to withstand oil volatility. Dialog’s consistent earnings 10-year CAGR of 19% even during the industry downturn back in 2014 amidst sharp decline in oil prices has proven its defensive business model against oil price volatility.

Exciting growth in FY20. Dialog is expected to achieve 22% earnings growth in FY20 (vs 5-year historical CAGR of 19%) on the back of 54% growth in its JV & associate contribution (PT2SB). Meanwhile, net margins next three years are expected to improve to 18.9-20.0% from 13.8% in FY18 following consolidation of Langsat terminals and lower proportion of EPCC & fabrication income.

Crystallising Pengerang Phase 3. Land reclamation of 300 acres for Pengerang Phase 3 is currently 47% completed and slated for completion by end of CY19. At this juncture, we understand that Dialog is in the midst of finalising its Phase 3A investment plan with the initial investment cost of RM2.5bn. Therefore, we believe the announcement of Phase 3 plan (possibly this year) would provide clarity on the potential client profile, equity stake, capacity as well as timeline will be the long awaited catalyst while eliminating replenishment risk for its EPCC & fabrication arm. Note that we have imputed RM0.56/share based on expected value of DCF assuming equity stake of 25-49%, 17% IRR, RM5bn capex, 70:30 debt equity ratio, 6.1% WACC.

Emerging as a strong potential JV candidate. As PIC is approaching completion, PIPC phase 2 development involving 1,899 acres of land, may kick start earliest in CY20. This will provide further investment opportunities for international petrochemical players to expand their footprint in Malaysia, which is in line with PIPC’s aim to become an international petrochemical hub. With the management’s intention to venture into petrochemical space via an equity stake, Dialog, in our view, could appear to be a strong JV partner for foreign players which intend to build a plant in Malaysia given its vast experience in EPCC, plant maintenance and deepwater terminal in Pengerang. That said, cash calls, in our view, are unlikely as Dialog has no intention take up a substantial equity stake backed by its firm balance sheet (net gearing of 0.15x as of 2QFY19).

Forecast. Dialog is expected to maintain its earnings growth trajectory, recording 9- 22% earnings growth in the next three years. Its CAGR of 13.6% is in line with the management team’s long term aim of 10%-15% earnings growth p.a.

Initiate with a BUY, TP: RM3.76. We are initiating coverage on Dialog with a BUY rating at a target price of RM3.76 (+18% upside), based on our Sum-of-Parts (SOP) model. While current valuation of 36x FY20 PE (+1.5SD to 5-year mean) is higher than its local and regional peers, we see upside on the counter premising on news flow on Pengerang phase 3, exciting earnings growth, margin expansion and rising ROE. Long term growth in Pengerang shall be further entrenched via its venture into petrochemical space.

Source: Hong Leong Investment Bank Research - 24 Apr 2019