We recently met with the management of BARAKAH and came away with a clearer picture of the industry dynamic and the company’s prospects. We believe that the company may secure slightly more pipeline servicing/replacement contracts (versus our previous less optimistic assumptions). In view of the more optimistic assumptions, we have adjusted our FY15E and FY16E earnings forecasts by 20% and 7% to RM81.0m and RM90.1m (as opposed to RM67.2m and RM84.0m previously) on the back of higher pipeline operations performed (100% for both FY15 & FY16 recognition versus 45% & 80% previously). Post our net profit upgrades and rolling forward valuation to CY16 EPS of 10.4 sen with target PER maintained at 10x, the new TP is RM1.04 (from RM0.78 previously). The higher target price prompts a rating upgrade to MARKET PERFORM (from UNDERPERFORM).

15M14 mired by upfront costs; forward prospects better due to lesser administrative costs. To recap, BARAKAH recorded 15M14 core net profit of RM88.6m on the back of: (i) the completion of several pre-commissioning job, (ii) commencement of Pan Malaysia T&I projects since June-14, and (iii) other on-going Onshore Engineering, Procurement, Construction and Commissioning (EPCC) project with a lower EBIT margin (14.3% in 15M14 vs 25.9% in FY13). Management clarified that the lower EBIT margin was mainly due to front-loaded administration expenses (due to ramped-up manpower force from 250 in 2013 vs 470 in 2014) in preparation of Pan Malaysia projects in early 2014. Moving forward, in the absence of such costs, better EBIT margin is expected (blended EBITDA margin to improve to 18.4% in FY15 vs 16.8% in 15M14).

Contract flows to continue, allaying initial fears. We are convinced that oil majors are unlikely to reduce pipeline servicing/replacement works significantly even in lower oil prices environment due to working environment safety issue. Thus, we feel more confident on BARAKAH’s earnings prospect, as it might be less impacted by major contracts slowdowns. As such, we expect BARAKAH to secure some pipeline servicing/replacement contracts while these contracts could be short-term in nature.

Order book stands at c.RM2.0b. With the recent PIG Trap System contract win, its unbilled order book stands at RM2.0b. This will provide earnings visibility for the group until 2018. Excluding the tender book for the Arab Saudi project, we understand that BARAKAH is actively bidding for c.RM400m- RM600m worth of projects.

Upgraded FY15E-FY16E net profits by 20% and 7% to RM81.0m and RM90.1m (previously RM67.2m and RM84.0m), respectively as we adjusted the percentages in FY15/16 revenue recognition of new wins (RM150.0m p.a.) from 45%/80% to 100% each as pipeline servicing/replacement typically is less than a year, while maintaining our FY15E-FY16E blended EBITDA margins forecasts of 18.4%-18.5%, respectively.

Upgrade to MARKET PERFORM with higher TP of RM1.04. Post earnings adjustment and rolling forward valuation to CY16 EPS of 10.4 sen with an unchanged PER target of 10x, the new TP for BARAKAH is pegged at RM1.04 (from RM0.78 previously). We have ascribed a premium over other small-cap stocks (7-9x) due to its status as a Pan-Malaysian contractor which ensures work continuity for the coming 2-3 years. With the more optimistic outlook, we upgrade our rating to MARKET PERFORM from UNDERPERFORM.

Risks to Our Call. (i) slower-than-expected in the Pan-Malaysia’s T&I project execution, and (ii) lower-than-expected margins.

Source: Kenanga