We attended SENDAI’s briefing and left uninspired with the company’s prospects. Highlights from the briefing were: (i) RM2.0b replenishment target in FY16, (ii) margin concerns, (iii) expansion plans, and (iv) potential fair value losses from Technics Oil and Gas Ltd. We lowered our FY16E earnings by 21% to RM51.5m as we lowered our margin assumptions and rolled out our FY17E CNP of RM54.2m. Downgrade to MARKET PERFORM with a lower target price of RM0.73 based on unchanged ascribed PER of 11x.

Project margins trending down... Since the slump in oil prices, the Middle East has seen a significant slowdown in the awards of iconic structure projects that typically yield lucrative net margins that range between 15% and 20%. As such, SENDAI’s pre-tax margin in Middle East are affected as reflected in FY15 (-2.0ppt, YoY to 4.1%). However, management indicated that the prospect in countries such as Qatar and Dubai remains promising, as these countries have not seen any major decline in typical development works. While these jobs yield lower margins as compared to iconic structure, SENDAI is still willing to participate in order to secure more jobs from the region to sustain its orderbook replenishments.

Growing concern in India. Recall that its losses in India in FY15 were mainly attributed to provisioning of unrecoverable VO claims in Worli Mixed Development. We remain concerned on its prospect in India due to the stiff competition in the market coupled with the difficulty to secure/retain skilled labours for their construction projects, as it would further lead to cost overruns due to the delays in its construction progress. Given the thin margin and execution difficulties in India, we strongly believe that management should re-look at the viability of its operations in India.

Diversifying geographically. While SENDAI remains optimistic on the prospects in Middle East at this juncture, they are exploring to venture into new territories such as Kuwait and other South-East Asian countries such as Thailand and Indonesia for more construction jobs to mitigate against the potential slowdown in Middle East. In terms of capital expenditure, managements are only looking to spend RM40m-RM50m for FY16 as they have already front loaded its expenditure in FY14 and FY15 boosting their structural steel capacity production to 220,000m3.

Targeting RM2.0b replenishment. For FY16, managements are stepping up their replenishment target of RM2.0b from RM1.7b last year, and among the projects which could contribute positively to the replenishment target include KL118, Dubai Eye, Jimah East project and RAPID. We feel that the target is achievable considering SENDAI has achieved RM1.7b in FY15, accounting for 113% of our FY15 target. As such, we increased our FY16 replenishment target from RM1.5b to RM2.0b. Its current outstanding orderbook of RM1.7b provides visibility for the next c.1 year.

More fair value losses? SENDAI’s 29.0% stake in Technics O&G Ltd Singapore has incurred RM9.5m losses on fair value at SGD0.62/share in FY15. Since then, the Technics’ share price has plunged over 74% to SGD0.16 (yesterday’s closing price). Based on SGD0.16, we would anticipate 1Q16 to register losses in fair value amounting to c.RM90m. However, we note that our CNP will not be impacted, as the fair value gain/losses would be excluded from our calculation.

Downgrade to MARKET PERFORM. We lower our FY16 CNP by 21% after factoring in lower margins for its on-going projects as SENDAI has been suffering from margins downtrend, especially from India. We also introduce our FY17E CNP of RM54.2m, underpinned by FY16E orderbook replenishment of RM2.0b. Nonetheless, we have a concern over its balance sheet given the spike in net gearing to 0.60x from 0.33x a year ago. Hence, post earnings revision, we downgrade SENDAI to MP with a lower TP of RM0.73 based on an unchanged ascribed PER of 11x.

Source: Kenanga Research - 4 Mar 2016