Period  3Q14/9M14

Actual vs. Expectations  MMHE Holdings Bhd (MHB)’s 3Q14 core net profit of RM20.0m led to core 9M14 net profit of RM90.1m. This is below both our full-year forecast (RM164.0m) and consensus (RM162.5m) estimate at 55.0% and 55.4%, respectively. Our 9M14 core net profit forecast excludes RM33.3m 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) lower than-expected profit contribution from the Offshore Business Unit as we misinterpreted the extent of the new accounting policy (which backloads majority of profits towards the tail-end of contract), (ii) lower-than-expected earnings from the Marine Repair business unit which took a surprising dip in 3Q14, and (iii) a loss in the JCE division caused by withholding tax.

Dividends  No dividend was declared as expected.

Key Results Highlights QoQ, core net profit was down by 43.4% namely due to: (i) lower EBIT earnings from the MBU division which took a 64.9% dip in 3Q14 caused by lower earnings-per-vessel repaired due to the intense competition for the segment and (ii) JCE losses caused by withholding tax, both of which took us by surprise. There was also lack of much OBU profits from new projects (which we had expected to trickle in by 1H14).

 YoY, core net profit contracted by 45.0% largely due to lack of profitable contributing projects in the current year given both Malikai and SK316 are on the “square method after threshold completion.”

 YTD, earnings are down by 33% on the lack of order replenishment and the change in accounting treatment for larger contracts.

Outlook  YTD, FY14 contract wins is RM323m, far from the RM1.5b that management had hoped to achieve this year. We understand that there is still one more bid in place, but the value of the contract is not exciting.

 Profit contribution for most of the OBU projects is guided to emerge only by 2H15.

 Thus far, tender book is still at RM3-4b but outlook still seems fluid at this juncture, especially given the crude oil price trend.

 Order book stands at RM1.7b (inclusive of the Bergading project which came in after Sep-14 (illustrated in 3Q14 briefing slides).

Change to Forecasts We cut our FY14E net profits by 34.8% as we: (i) disregard any contributions from the Malikai and SK316 projects, (ii) cut margins on OBU division to 4.5% from 5.5% previously, and (iii) reduce our MBU earnings assumptions.

 For FY15, we have trimmed our net profits by 35.9%; firstly as we have assumed lower contracts being brought forward from FY14. We are also reducing our OBU contract wins assumption to RM2b (from RM3b) in FY15E in light of the sluggish sentiment regarding crude oil prices, which could impact capex spending in the short-run as well as the MBU units earnings given the stiff competition.

Rating Maintain UNDERPERFORM

Valuation  We have reduced our FY15E target PER on the stock to 16x (from 17x) as we believe that the stock should trade at a further discount to large-cap stocks which we deem should be pegged at 17-18x (+0.5x std deviation on historical 5-year forward PER for the sector) given the weakness in forward prospects.

 The earnings cuts and PER trim leads to our TP falling to RM1.84 (from RM3.06).

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

Source: Kenanga