· Well-known global crane manufacturer to watch. FAVCO offers highspeed, high-capacity customised cranes under two renowned brands “Favelle” and “Kroll”. It focuses on offshore crane manufacturing, serving shipyards and big oil majors such as Keppel FELS, ExxonMobil, Shell, Petronas and NCOOC. In addition, FAVCO also supplies tower cranes that were used to build some of the world’s tallest buildings like Burj Khalifa in United Arab Emirates, Shanghai Tower in China and One World Trade Centre in New York.

· Firm orderbook of approximately RM1b. We were guided that purchase enquiries remain intact but timing of order conformation is uncertain as clients might be taking a “wait-and-see” attitude. As at YTD May 2015, FAVCO has secured RM85.7m order, bringing total outstanding orderbook to RM967m. We anticipate the company will secure more orders in the second half in view of stabilising crude oil prices. However, it could be hard to maintain the same level of replenishment as last year due to the slowdown in oil and gas industry and massive capex cut from oil majors. With an estimated burn rate of 60% in FY15, we project full-year FY15 revenue to grow 10.3% y-o-y to RM879.8m but subsequently dropping slightly to RM853.2m in FY16.

· Margin improvement mainly owing to continuous cost optimisation ... We came to understand that crane manufacturing business typically generates net margin of 8%. That said, FAVCO has been achieving net margin ranging between 8.5% to 10.5% in the past three years. For the most recent two quarters (4Q14 and 1Q15) net margins were even higher, at 12.1% and 11.8% respectively. We are confident of company maintaining its net margin, at least at the low double-digit levels, riding on its ability to minimise cost leveraging with a global geographical presence.

· ... but not on forex gains. However, limited gain from stronger USD is expected due to high currency hedge ratio. More than 50% of FAVCO’s sales orders are denominated in USD and the company has taken a relatively conservative approach to hedge approximately 60% of its USD currency exposure. Therefore, FAVCO may not able to benefit much from the recent strengthening of the greenback.

· Crane maintenance plant in operation since beginning of FY15. FAVCO started to offer crane maintenance services by operating a new plant in Kemaman, Terengganu since early of the year. The plant aims to create more recurring income by extending its maintenance services to non- FAVCO-manufactured cranes while seeking for more business opportunities in East Coast Malaysia. The contribution from the plant is minimal and insignificant at this point of time.

· Decent dividend yield backed by rich cash position. FAVCO has been consistently distributing dividend with an average payout ratio of 28% in the past five years. Assuming the same payout ratio is maintained in FY15 and FY16, this could translate into a dividend yield of 4.1% and 3.9%, respectively. We believe such dividend distribution is likely as the company is in net cash position of RM185.0m as of 1Q15 coupled with healthy cash flow from operations.

· Not rated for now. At 8.0x CY16 PER, FAVCO is fairly valued at RM3.11, which is within the PER band of 7-10x for small-mid O&G stocks. FAVCO was last traded at RM2.76, implying CY16 PER of 7.1x, slightly higher than its five-year average PER of 7.0x. Higher premium is warranted for FAVCO over other small cap players in the industry due to its strong cash position and ability to improve margins in the challenging environment. However, given the current market sentiment which remains lacklustre towards the oil and gas sector, FAVCO is a Not Rated stock for now. However, we will continue to monitor the stock closely, especially on whether FAVCO would be able to surprise the market with more crane orders in the coming quarters.

Source: Kenanga Research - 23 Jul 2015