We Participated in a Conference Call With the Management of Serba to Get An Update on the Company. We Opine That Serba Is Still Expected to Record Strong Earnings Despite the Volatility and Challenges in the O&G Industry. All of Its Expiring O&M Contracts Are Expected to be Renewed and the Company Believes That It Will be Able to Maintain Its Margins. While Job Tenders Have Slow Down, Tender Bids Remain Healthy at About 6-10 Tenders Per Month (as Compared to 12- 15 Per Month in FY19). FY21 Orderbook Growth Is Expected to be Underpinned by Its ICT Segment and the Teluk Ramunia Yard Is Expected to Improve Overall EPCC Margins. Maintain BUY, With TP of RM2.50 Based on 13.5x FY21EPS.

New job tenders are slowing down but tender bids remain healthy. Serba’s tender bids for O&M and EPCC jobs have slowed down from an average of 12-15 tenders in FY19 to about 6-10 tenders per month in 3Q20. The decrease in tenders is primarily attributable to lower global economic activity for the O&G segment due to Covid-19.

BiEH and PeIP. Serba has completed the construction of BiEH and is expected to begin operations in November 2020 while PeIP is close to completion and is expected to be ready by 1Q21.

Block 7 innovation hub and data centre project. The Company has finished the preliminary works for its RM7.7bn innovation hub project and physical construction works are expected to start by 1H21. Serba is currently doing the design works for its data centre project in UAE and preliminary works are expected to begin by 1H21.

Teluk Ramunia. Serba has completed handover of the yard from Petronas and have started internalizing some works which were previously subbed out to other contractors. It is also trying to lease out some land to other O&G players situated within a close proximity to the yard. However, extra works in Teluk Ramunia might not commence in 4Q20 due to the monsoon season. The lean structure of operations in Teluk Ramunia is expected to allow the yard to be profitable. Internalisation of previously subbed-out works is expected to add c.1-2% for its EPCC margins.

2021 orderbook growth is expected to be underpinned by its ICT segment. Serba believes that there is ample room to grow its ICT business as the Company expects to secure more contracts from Zambia and other parts of Africa.

No need for equity raising in the near future. Serba’s existing cash balance is sufficient to support its working capital requirements for the next 6-12 months. Serba also has RM2bn of unutilized debt facilities to drawdown if need be.

Outlook. We believe that prospective job wins for Serba is expected to slow down in 2021 due to current economic activity. However, the trend of renewals for existing O&M contracts are still happening and we expect its O&M margins to be maintained going forward as there have been no contract renegotiations thus far. Its orderbook backlog of RM18.5bn would also be able to sustain its earnings growth in the next 2 years as the burn rate for the Block 7 and innovation hub contract is only expected to peak in FY22. Its Teluk Ramunia yard is also expected to improve its overall operational performance and margins as it would be able to internalize more contracts that were previously subbed out. It can also tender for more projects with its new yard in place.

Forecast. No Changes.

Maintain BUY at TP of RM2.50 based on 13.5x FY21 EPS. We maintain our BUY call on Serba as we believe that (i) the recent weakness in its share price presents a very good opportunity to buy into the stock as our TP implies an upside potential of almost 70%, (ii) Serba would be able to maintain its high EBIT margins for its O&M division, (iii) the recurring nature of its O&M orderbook would ensure earnings sustainability in the foreseeable future despite lower prospective contract wins in FY21 and (iv) earnings are expected to grow exponentially in FY22 when its Block 7 project hits its peak earnings phase.

Source: Hong Leong Investment Bank Research - 6 Nov 2020