We feel more comfortable with PANTECH’s recent venture into hot-dip galvanising after a meeting with its management yesterday. Operated through a JV, this new venture will provide PANTECH with a new revenue stream as well as cater for in-house galvanising requirements and eventually results in cost saving for its manufacturing division. CAPEX required to set up the manufacturing plant is estimated at RM30m or RM15.3m to PANTECH for its 51% stake and it will be fully funded internally. Revenue contribution is expected only in FY18 with a minimum 20% utilisation anticipated. Meanwhile, we were guided that 2H16 is expected to fare better underpinned by stronger orders from RAPID project, but full-year FY16 earnings will be flattish YoY as the industry’s pace remains slow. Maintain MARKET PERFORM with an unchanged TP of RM0.60 pegged to 8x CY16 PER.

New business venture. To recap, PANTECH entered into a 51:49 JV agreement with Euromech Machinery Sdn Bhd (EMSB) end of last month to form a new company namely Pantech Galvanising Sdn Bhd (PGSB). The JV allows PANTECH to leverage on EMSB in sourcing expertise to run the galvanising business while PANTECH is capable of securing orders utilising its strong presence in the local oil and gas sector. Hot-dip galvanising is a process of coating steel and iron with a layer of zinc at high temperature which is widely used as a lower cost corrosion resistance manufacturing process. We were guided that the local galvanising business is led by Industrial Galvanisers Corp Sdn Bhd (IGC), followed by All Pak Industries Sdn Bhd (All Pak) and CK Galvanising Sdn Bhd (CK). We believe the new business will complement its existing manufacturing business as the company will no longer need to outsource its galvanising job for the manufacturing process of pipes, valves and fittings (PVF) whilst also creating a new source of income.

Building factory with a capacity of 48,000 mt p.a. PGSB aims to set up a new galvanising factory at Tanjung Langsat with a targeted CAPEX of RM30m, including the cost of land acquisition, necessary tanks and equipment. With a 51% stake in PGSB, the cost of RM15.3m will be funded internally with no borrowings required. The new site will provide a manufacturing capacity of 48,000mt p.a. and is targeted to complete by end of FY17. With the commencement of the plant, PGSB will have an equivalent manufacturing capacity as its main competitor, IGC which is the largest player in the domestic market and almost twice the capacity to All Pak and CK.

Orders to kick in earliest at 1QFY18. We believe PGSB will contribute positively to PANTECH in 1Q18 earliest. Assuming the plant running at a 20% capacity on the first year, the galvanising business is estimated to contribute RM11.5m revenue and PGSB could either break even or run into a slight loss due to fixed overhead cost. Nevertheless, in the long run, the company is confident of increasing its utilisation rate by securing more orders from RAPID project with a potential demand of c.1m mt of galvanising services in the next few years.

Expecting stronger 2H16. We believe PANTECH will perform better in the second half of FY16 backed by increasing PVF orders from the RAPID project in Pengerang as well as cost cutting measures resulting in RM1m saving per annum. Like any other oil and gas peers, PANTECH has also embarked on cost optimisation program under the current challenging environment and the impact is expected to be seen starting from 2H16.

Maintain MARKET PERFORM. The galvanising business could be a medium-to-longterm catalyst to PANTECH as the potential earnings contribution from the completed plant at Tanjung Langsat at full capacity would be up to RM5.5m (assuming 15% net margin) which is a 10% upside to its CY16 earnings of RM51.4m. Although we are positive on its expansion into the galvanising business, we do not discount the possibility that it could potentially trigger a price war among players and eventually lead to margin compression. TP is maintained at RM0.60 pegged to CY16 8x PER, which is consistent with the valuation applied to the small cap players across the oil and gas sector.

Source: Kenanga Research - 16 Oct 2015