We believe the three-year Nord Stream 2 AG 2,400km pipe coating contract is a re-rating catalyst to WASEONG as it provides more earnings certainty for the future. Although the contract value has yet to be finalised, we believe the total contract value could be more than RM2.0b, which is a strong boost to existing order book of RM715m. Hence, we are doubling FY17E earnings and upgrade the stock to OUTPERFORM with a higher TP of RM0.86.

Concrete weight coating of 2,400km pipes. Making reference to the announcement made by Nord Stream 2 AG, WASEONG announced that its indirect wholly-owned subsidiary in Netherlands has secured a contract of concrete weight coating and storing of approximately 2,400km of pipes. The contract award is subject to final negotiations and will be signed in the coming weeks while the final contract value will be disclosed thereafter. It is expected to commence in September 2016 and completed by 3Q19.

Contract value estimated to be >RM2.0b. We are positive on the announcement as it provides three years of earnings certainty till FY19. While the contract value has yet to be firmed up, we estimate the contract size could be more than RM2.0b. Recall that WASEONG secured a 520km of pipe-coating work worth RM611m back in 2013. Therefore, on that basis, a 2,400km pipe-coating work could be worth up to RM2.8b. However, we believe the contract value may differ subject to the actual job scope and technical difficulty. Furthermore, the contract size could have shrunk given that the industry is still in a cost optimisation mode.

Re-rating catalyst. Assuming the new contract secured is worth RM2.0b which is RM666.7m per annum, it would boost order book by another 279% from the depleting amount of RM715m as of 1Q16. This is also beyond our order book replenishment assumption of RM400m each for FY16 and FY17. Hence, we believe it is a strong re-rating catalyst for the company. Assuming a gross margin of 20%, the contract will increase the gross profit by additional RM133m p.a. (which is equivalent to 50% of FY15 gross profit).

Doubling FY17E earnings. All in, we maintain our FY16E forecast as we believe the initial earnings recognition from the contract will be minimal. FY17E earnings estimate is increased by 86% factoring full-year recognition from the contract.

Upgrade to OUTPERFORM. Our TP is increased to RM0.86 from RM0.68 on higher PBV of 0.5x from 0.4x previously as this contract award provides more earnings visibility to the company in the current industry downturn. We believe our valuation is still conservative as the assigned target PBV is also consistent with its -1.5SD below to its 5-year average Fwd. PBV.

Risk to our call includes: (i) Weaker project execution than expected, (ii) smaller contract size than expected, and (ii) lower-than-expected margins.

Source: Kenanga Research - 12 Jul 2016