Last week, we visited SENDAI’s Middle Eastern operations, which include their Structural Steel, as well as Oil & Gas business. We were impressed with SENDAI’s technical expertise given (i) the complexity of structures constructed, and (ii) the successful construction of their first lift boat despite being a new player in the O&G field. Nonetheless, as earnings estimates remain unchanged post visit, we maintain our UNDERPERFORM call and TP of RM0.74.

Middle East sustainable. While there is mounting price competition in the Middle East, clients there value a balance between price and quality. Therefore, SENDAI’s track record in the Middle East enables it to command them a slight premium over other structural steel contractors. Thus, we believe margins moving forward would remain sustainable (PBT margins of 8-9%) amidst the price competition. That said, given the complexity of these jobs, an unforeseeable problem could easily lead to potential cost overruns.

Other regions weaker. Meanwhile, in other regions of operations (Malaysia, India and Thailand), clients are extremely price sensitive and would always favour the lowest bid over execution track records. Due to the overly competitive landscape, we believe it is tough for SENDAI to compete given that they do not compromise on quality. Hence, we expect the weak and volatile margins to persist within these regions stemming from low margin jobs and underutilisation.

Saudi Aramco a boon... but O&G still inefficient now. While O&G profitability has been subdued, we see a silver lining within this segment as SENDAI has gained some traction with Saudi Aramco (world’s largest oil company) with their first project set to be delivered by 2H18. Should they manage to deliver the project successfully, we opine that there could be bigger jobs up for their grabs. Nonetheless, we believe earnings within O&G would likely continue to remain weak and volatile in FY18 due to its poor outstanding O&G order-book of RM220m with a year visibility leading to an inefficient operating level in this segment. Note that the O&G segment has yet to secure any contract YTD despite their sizeable tender-book of RM12.0b.

First sail off. SENDAI began its sea trial for their first liftboat on 21st March 2018. The liftboat can be delivered to Vahana once the sea trial is completed along with some fine tuning. We expect the delivery to happen latest by June-18 once Vahana secures a charter contract and the corresponding financing bank (of Vahana) releases the remaining payment of USD36m (RM141m) to SENDAI. SENDAI’s net gearing is expected to fall to 0.81x (from 0.97x) post-delivery. Meanwhile, SENDAI’s second liftboat that is at 30% completion is currently put on hold. We believe the second liftboat would require further financing to progress and we only expect it to be delivered earliest in FY19.

FY18/19E earnings estimates remain unchanged post visit.

Maintain UNDERPERFORM with an unchanged TP of RM0.74 based on 8x FY18E PER (lower end of our applied 8-13x PER among small- to-mid cap universe). Overall, we choose to maintain our UP rating based on unchanged valuations due to risks from SENDAI’s existing; (i) high net gearing of 0.97x vs average peers’ net gearing of 0.10x, (ii) inefficient operating levels at India, Malaysia and O&G segment, (iii) delayed payment risks of USD36m should VAHANA fail to secure a charter for the first lift boat, and (iv) potential impairment risks for the second liftboat should Vahana fail to raise financing for the takeover.

Upside risks include: (i) huge wins from Saudi Aramco, (ii) higher-than- expected replenishment, and (iii) better-than-expected margins.

Source: Kenanga Research - 27 Mar 2018