Period  2Q14/1H14

Actual vs. Expectations MMHE Holdings’ (MHB) 2Q14 core net profit of RM35.4m led to core 1H14 net profit of RM70.1m. This is below both our (RM212.4m) and consensus (RM226.9m) full-year estimates at 33.0% and 30.9%, respectively. Our core net profit excludes RM14.3m tax incentive credit and c.RM10m one-off Mandatory Separation Scheme (MSS) expenses that hit MMHE in 2Q14.

 The lower-than-expected performance is mainly due to: (i) higher-than-expected costs that are considered VOs for projects that recently sailed away (i.e. Tapis-R and Kebabangan) and (ii) slower-than-expected income recognition from the Malikai project which was expected to come in this quarter.

Dividends  No dividend was declared as expected.

Key Results Highlights QoQ, despite a jump in revenue by 46.1%, core operating profits (c. RM33.2m should we exclude the one-off RM10m VSS costs) tanked mainly due to higher-than-expected costs from projects that recently sailed away (i.e. Tapis EOR and Kebabangan).

 YoY, the core net profit contracted by 28.6% largely due to lack of profitable contributing projects. In 2Q14, both the Malikai (30% project completion) and SK316 (13% project completion) contributions have yet to kick start and although the Malikai project has reached MMHE’s profit-recognition completion threshold of 25%; we understand the project will now be recognised utilising a new conservative method which is applied to projects that are off EPCIC in nature.

Outlook  Management guides that it will be utilising a more conservative profit recognition method (“square method after threshold completion’) to reflect the ‘riskiness’ of material lump sum projects (which include Malikai and SK316). The method sees the majority of profit margins at the tail-end of the project (versus a general increasing profit margin over the lifetime), hence essentially it implies that profits on such projects are backloaded.

 Orderbook currently stands at RM1.8b with the Malikai and SK316 projects being the largest contributors. Tender book stays at RM4-5b, but we note that contracts win target seem to have dwindled to RM1.5b in FY14 (versus RM2b previously).

However, that is unsurprising as we had mentioned in our 3Q14 strategy that fabrication contract awards could be backloaded to the year-end.

 Outlook for margins seems similarly weak, given the heightened domestic competition (we note that global players have been gaining traction in large job wins; whilst there are a number of smaller fabrication players that want a cut of the contract pie).

Change to Forecasts   We trim our FY14 net profits by 22.8% as we shift most of the profit recognition for Malikai and SK316 to FY15.

 For FY15 we have trimmed our net profits by 10.1%. Despite a spill-over of profit recognition from FY14, (i) delay revenue recognition for newer projects given fabrication awards still seem to be slow and the profit recognition for material projects seem to be backloaded; and (ii) lower our EBIT margin assumptions to 5.5% (from 6.5%) for the offshore division given guidance of more competition moving ahead and the backloading in profits

Rating Maintain UNDERPERFORM

Valuation  Our TP is now down to RM3.24 (from RM3.60) based on an unchanged PER of 18x on FY15 EPS.

Risks to Our Call (i) higher-than-expected project wins; (ii) better-than expected margins, and (iii) acceleration in project executions.

Source: Kenanga