We are now taking a more conservative view of MHB’s prospects and are downgrading the stock to an UNDERPERFORM after our recent meeting with management. We understand that: 1) the upcoming fabrication contract awards could be delayed; 2) there could be no earnings contribution from the Malikai TLP project in FY13; and 3) margins may continue to be flat moving ahead. As such, we are reducing our FY13-14 net profit forecasts by 34.0% and 30.2% respectively. Correspondingly, our target price has also been cut to RM3.39/share from RM4.05 previously, based on an unchanged 18.0x PER of CY14 earnings.

Delay in fabrication contract awards. Contrary to our initial view that fabrication contracts will be dished out by mid-2013, we learnt that most of the larger fabrication contract awards could be pushed to end-2013 and/or early to mid-2014. Management is not exactly clear on the reasons for the potential delays but given this scenario, it believes that the company may not be able to meet its targeted RM3.0b contract wins for FY13.

Current order book will largely be depleted by FY13. As at Dec-12, MHB's order book stood at RM3.0b. However, c.60% of the order book is expected to be completed in 2013. On the other hand, management is uncertain if it can achieve the requisite 25% threshold of its revenue recognition policy for the Malikai TLP project, which means any contributions are likely to be only in FY14. Again, this is also contrary to our initial assumption. The Malikai TLP project is expected to be completed by 3QFY15.

Margin expansion unlikely for now. MHB has embarked on cost rationalisation and efficiency enhancement exercises to improve its execution track record and margins. In its bid to do so, one of the strategies was to sign long-term agreements with five key contractors on the provision of structural fabrication services, and long-term agreements with 19 vendors on the supply of structure, piping and electrical and instrumentation materials. While this should result in future margin expansions for the company, we understand that the impact would not be in the near-term as the restructuring takes time, and that the new long-term agreements will only impact fabrication contracts won after the Malikai TLP project. These, as mentioned, could only come in by 2014, at the earliest. Moreover, we understand that future tenders could increasingly be open to international competitors, which could put a cap to any potential exorbitant margin expansions moving forward. In our view, all these factors could mean that FY13 margins could be at best, flat in the near term.

Forecasts reduced. Based on the reasons above, we are now taking a conservative view on MHB's prospects. Hence, we are trimming our: 1) order book replenishment for FY13-FY14 to RM1.5b and RM3.5b respectively, from RM2.8b and RM4b previously; and 2) EBIT margins to 5.5% and 6.5% respectively, from 8.5% and 9.0% previously. On the overall, we are cutting our FY13-14 net profits by 34.0% and 30.2%.

Rolling target price valuation to FY14 and trimming target price. We have rolled-forward our earnings base to FY14 as we are approaching the mid-year. Consequently, our target price drops to RM3.39, from RM4.05 previously, based on an unchanged 18x PER with the lower FY14 EPS of 18.8 sen.

Downgrading our call to an UNDERPERFORM. At this juncture, the stock is trading at CY14 PER of 20.3x vis-à-vis the CY14 PER of 14.8x that SapuraKencana Petroleum Bhd (“SKPETRO”, OP; TP: RM4.15) is trading at. We view this as expensive considering that both stocks offer similar net profit growth of c.25.3-26.7%. Given our target price implies a 10.5% downside to current share price we are downgrading our call to UNDERPERFORM, from MARKET PERFORM previously. Catalysts for a change to our call would be higher-than-assumed job wins and Group margins.

Source: Kenanga