Period

1Q16

Actual vs. Expectations

1Q16 results came below expectations with core net earnings of RM9.1m accounting for only 17.2% and 17.5% of our and market consensus, full-year estimates. The deviation was due to lower-than-expected EBIT margin in the manufacturing division due to intense price competition.

Dividends

A 1st interim NDPS of 0.5 sen was declared in 1Q16 which is lower than the 1.0 sen paid in 1Q15.

Key Results Highlights

1Q16 core net profit rose 18.8% QoQ to RM9.1m due to the trading division recording higher revenue (+14.3% QoQ) and stronger margin (11.7% in 1Q16 vs 4.9% in 1Q15). On the flipside, manufacturing revenue slid marginally by 2.1% with a weaker EBIT margin of 11.4% (declined from 16.8% previously).

However, the 1Q16 core earnings plummeted 32.8% YoY largely attributable to sharp margin compression (down 8.5ppt to 11.4%) in manufacturing division despite the rise in revenue. We believe the poor margin could be due to weaker earnings contribution from its UK manufacturing plant arising from price cutting in order to secure jobs.

Outlook

Near-term outlook remains sluggish due to the challenging oil and gas industry amid uncertainties in crude oil prices. In view of maintaining the plants’ utilisation rate, we opine the company will take on more orders to manufacture lowermargin products. Hence, we expect margin to remain weak in the coming quarters.

Meanwhile, we expect the UK manufacturing division (Nautic Steels) to stay weak in the coming quarters since it mainly supplies to deepwater offshore players operating at North Sea Region, which is experiencing a massive slowdown.

On a positive note, we expect trading segment to have better prospect in 2H16 and FY17, underpinned by increasing PVF demand from RAPID project as the bulk of earlier works, which were mainly earthworks have been completed.

At the same time, we are guided that PANTECH stands a good chance to bag RAPID-related orders potentially worth up to RM80m to supply pipes and fittings in the next few months with an estimated gross margin of 10%. Should PANTECH secures this deal, we believe it is a good start and its trading revenue would be able to anchor future earnings in the longer run.

Change to Forecasts

We cut our FY16E and FY17E core earnings forecast by 9.4% and 8.4%, respectively, after adjusting our EBIT margin assumption downwards to 15% and 14% from 19% and 18% for stainless steel and carbon steel manufacturing plants, respectively, in view of price cutting and lower-margin productmix. Thus, our NDPS forecasts are also reduced to 3.3 sen/3.5 sen for FY16/17E assuming the same dividend payout ratio of 35%.

Rating

Maintain UNDERPERFORM

Valuation

Post our earnings cut, we reduced our TP to RM0.67, from RM0.74 previously, based on an unchanged 9.0x CY16 PER on fully diluted basis.

Risks to Our Call

(i) Faster than expected recovery in the trading division.

(ii) Stronger than expected growth in manufacturing exports.

Source: Kenanga Research - 24 Jul 2015