Period

2Q16/1H16

Actual vs. Expectations

The 1H16 results came in below expectations with core net earnings of RM19.6m accounting for only 41% and 38% of our and market consensus’ full-year estimates, respectively. The deviation was mainly due to lower-than-expected EBIT margin in the manufacturing division due to intense price competition.

Dividends

A 2nd interim NDPS of 0.6 sen was declared in 2Q16 which is lower than the 1.0 sen paid in 2Q15. This brought 1H16 dividend to 1.1 sen, which only accounted for 33.3% of our estimate.

Key Results Highlights

2Q16 core net profit rose 14.3% QoQ to RM10.4m due to the stronger margin in manufacturing division driven by more favourable product mix (18.0% in 2Q16 vs. 11.4% in 1Q16) despite an overall 12.4% fall in topline which was mainly led by slower manufacturing orders.

However, the 2Q16 core earnings plummeted 22.1% YoY largely attributable to lower demand of pipes, valves and fittings (PVF) for oil and gas projects which caused a 14.1% YoY revenue slump in both trading and manufacturing segments.

In 1H16, cumulative core net profit plunged 27.5% YoY mainly caused by margin compression arising from intense price competition (EBIT margin dropped to 12.2% in 1H16 compared to 15.2% previously) as well as lower work orders received and performed.

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 lower-margin products. Hence, we expect margin to remain weak in the coming quarters.

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

On a positive note, we expect its trading segment to see 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.

We were guided that PANTECH is likely to deliver its first RAPIDrelated orders worth c.USD12m in the 2H16 and the company is looking to secure more orders from RAPID project despite a slight delay in the progress.

The recent JV into the galvanising business will be a mediumlong- term catalyst to PANTECH but the potential revenue contribution will only kick in earliest FY18.

Change to Forecasts

We cut our FY16E core earnings forecast by 6.9% after adjusting the average selling price (ASP) for both carbon steel plant and stainless steel plant downwards to RM5,000/mt and RM3,000/mt from RM5,500/mt and RM3,300/mt, respectively, in view of price cutting amid tight competition.

We also trimmed down the revenue contribution from trading division by 5% for FY16 which leads to lower FY17 net profit forecast at RM50.6m (2.9% lower than previously forecasted) with ASP assumption for FY17 maintained as before.

Thus, our NDPS forecasts are also reduced to 3.1 sen/3.4 sen for FY16/17E assuming the same dividend payout ratio of 35%.

Rating

Maintain MARKET PERFORM

Valuation

Post our earnings cut, we reduced our TP to RM0.58, from RM0.60 previously, based on an unchanged 9.0x CY16 PER.

Risks to Our Call

(i) Weaker than expected performance of the trading division.

(ii) Lower than expected selling prices of pipe fittings & valves.

Source: Kenanga Research - 22 Oct 2015