We initiate coverage on Serba as it is one of the few O&G related stocks that is relatively insulated from the volatility in oil prices with strong earnings track record. Serba has experienced a steep decline in its share price when oil prices plunged in March and we opine that valuations are still undemanding at this juncture. The Company has proven that it can maintain its overall EBIT margins for its O&M division (c.20%) despite the challenges it faced during the MCO. Its current oderbook of RM18.5bn (+85% YoY) is mainly underpinned by its RM7.7bn innovation hub contract (EPCC) win from Block 7 LLC (LIWA Petroleum) in UAE. Its current EPCC orderbook to revenue cover is at 14x, while its O&M contracts are mostly recurring in nature. While most oil majors have continued with its capex cuts, Serba has been able to secure new contracts of material value, a testament towards its ability to become a giant conglomerate with exposures across O&G and IT. We initiate coverage on Serba with a BUY call at TP of RM2.50 based on 13.5x (3 year mean P/E) FY21 EPS.

Strong growth and earnings sustainability underpinned by sizable orderbook.
We expect Serba to experience revenue CAGR of 37% from FY20-22F due to its large orderbook backlog. Of its RM18.5bn orderbook, 40% of it is from its O&M division, which are recurring in nature, commanding an EBIT margin of about c.20%, while its EPCC contracts are mainly attributable to its RM7.7bn UAE contract. The bulk of its EPCC contract earnings are expected to peak in FY22.

Strong presence in Middle East. We believe that Serba’s strong presence in the region would bode well for them as it has a proven track record and close relationship with many of its counterparts. Its RM7.7bn EPCC contract in UAE is a testament towards its ability to secure material contracts in the aforesaid region. It also commands an attractive EBIT margin of about c.20% in the Middle East for its O&M business. About c.60-70% of its O&M contracts comes from the Middle East.

Sarawak play. We view that Serba’s stature as a “Sarawak company” would open up more opportunities for them. Recall that most MCM/HUC/Plant turnaround contracts were predominantly awarded to Sarawak based companies, and this trend is expected continue when Petronas decides to elevate its capex spending.

Forecast. We forecast FY20 core earnings to come in at RM556.6m (+12% YoY), a very commendable return in spite of the volatile and weak O&G market. We believe that Serba’s earnings would peak in FY22 when its Block 7 contract goes through its peak earnings phase in FY22. We forecast profit to grow by c.12/12/28% for FY19- 22F, implying a 3-year CAGR of 17.1%

Dividend. We expect Serba to stick to its dividend policy of paying out at least 25% of its net earnings yearly. This would imply a current yield of 2.7/3.0/3.9% for FY20-22F.

Risks. Downside risk to our forecast include (i) shortfall in meeting orderbook replenishment targets, (ii) intense competition from other players with similar business models, (iii) weaker than expected economic environment dampening demand thereby causing margin erosion and (iv) continued downturn in the O&G sector.

Initiate with a BUY, TP: RM2.50. Our TP is based on FY21 EPS of 18.4sen pegged to a PE multiple of 13.5x, which is its 3 year mean P/E. Our TP implies an upside potential of almost 50% including dividends, we believe this is justified as it is likely that Serba would be able to maintain its high margins amidst the weak O&G market. Serba currently has the highest EBIT margins for O&M in Malaysia and the recurring nature of its O&M contracts and rapidly growing EPCC orderbook would ensure earnings sustainability in the foreseeable future.

Source: Hong Leong Investment Bank Research - 14 Sept 2020