Although 3Q17 results were sequentially stronger than 1H17, low profit margin at the early stage of Alex Corp?s upgrading contract pulled overall profit margin lower thus 3Q17 results were weaker than expected. Nonetheless, as certain projects are now moving into advanced stages, producing better profit margins as well as higher progress payment claims, PESTECH should end FY17 at a higher note. We maintain our OUTPERFORM call with an unchanged target price of RM2.00/SoP share, for its earnings growth story led by the exciting Indochina power infrastructure spending.

3Q17 below expectations. PESTECH reported 3Q17 results which came below expectation with core profit of RM17.4m, bringing 9M17 core profit to RM40.6m which accounted for 53% of our FY17 full-year estimates. The divergence between actual results and our estimates were because Alex Corp?s upgrading job brought in higher revenue, but profit margin was lower as the job just started in February, still at an early stage. There was no dividend declared in 3Q17 as expected.

A better sequential quarter. In fact, 3Q17 was a better quarter as opposed to 2Q17 which saw its core profit rising 15% QoQ to RM17.4m from RM15.1m as revenue surged 42%. As mentioned earlier whereby higher revenue contributed by Alex Corp?s job for its early stage of the new upgraded contract pushed topline higher, suppressing its profit margin. As a result, group EBIT margin fell to 14% from 24% previously. Meanwhile, judging from the minority interest, work claim recognition was lesser for Diamond Power (DPL) while work progress for Subang Skypark and KDVT were on track as planned.

Mixed results compared to last year. While revenue jumped 38% from 3Q16, 3Q17 core earnings rose 53% from RM11.4m last year which was partly attributed to more progress claims this year as opposed to last year. However, YTD 9M17 core earnings fell 17% to RM40.6m from RM49.1m in 9M16 although revenue rose 24%. This is largely due to higher minority interest as the progress claims for DPL was higher this year compared to the same period last year while work progress claims for the non-DPL projects were lower this year compared to last year.

Looking to a strong 4Q17. Although 3Q17 was a better quarter compared to 1H17, lower profit margin for the early stage of the upgrading of Alex Corp?s job resulted EBIT margin for 3Q17 to deteriorate to 14% from 21% in 1H17. Nonetheless, 2H, especially 4Q is always a strong period seasonally as it enters the dry season, coupled with some contracts are now moving into advanced stages in the coming quarters, resulting in better progress claims and profit margins. With the 2nd Alex Corp?s contract worth USD100m won in April, its current orderbook stands at c.RM1.54b with earnings visibility up to end-2019. Meanwhile, with the weak profit margin recorded in 3Q17, we cut FY17-FY18 estimates by 6%-8% mainly to adjust for lower profit margin. We also introduced FY19 estimates with earnings expected to grow at 10%.

Reiterate OUTPERFORM. While 3Q17 was slower than expected, we remain positive on PESTECH for its growth story, especially for the Indochina growth area. In addition, as its billings are priced in USD and payment guaranteed by financiers like World Bank and Asian Development Bhd, risk of default payment is fairly low. Maintain OUTPERFORM call with price target remained at RM2.00/SoP share after rolling over our valuation base year to CY18 from CY17 previously. Risks to our call include failure to replenish order book and cost over-runs.

Source: Kenanga Research - 29 May 2017