4Q18 results were a big let-down which led to its first FY earnings decline, in FY18. However, we remain upbeat on PESTECH for its exciting earnings growth story and believe this quarter’s earnings weakness should only be a temporary blip. We cut FY19 earnings estimates by 13% on lower EPC profit margin by 1%, but it remains OUTPERFORM with a revised TP of RM1.95/SoP share.

FY18 missed expectation. A dismal 4Q18 set of results with core loss of RM0.6m brought FY18 core profit to RM62.2m which came 32% below our estimate of RM92.1m, largely due to weaker-than- expected EPC project margin as those projects were in the beginning stages as well as the adjustment on DPL contribution, which had since started concession fees in January. There was no dividend declared for the year which was disappointing as well as we had projected for 3.6 sen NDPS in FY18.

First quarterly losses on DPL adjustment. 4Q18 plunged into core loss of RM0.6m after adjusting for RM7.8m unrealised forex loss and RM32.5m gain on hedging instrument. This was against core profit of RM15.0m in 3Q18. The losses were due to: (i) weaker top-line as the two main Alex Corp’s projects were still in foundation stages with minimal work claims, (ii) MRT2’s rail electrification was in design stage, which also entailed minimal work claims, and (iii) adjustment of overstated recognition of DPL in 3Q18 after it started receiving concession fees in January. Based on the MI reported in 2H18, the earnings contribution from DPL could be RM5.5m per quarter from c.RM16m previously during the construction period. All these explained the plunge in 4Q18 revenue and the lower bottom-line.

First earnings decline in a financial year. While revenue rose 4% YoY in 4Q18 and surged 66% in FY18, 4Q18 slipped into the red from core profit of RM45.4m and FY18 core profit contracted 30% to RM62.2m from RM89.1m previously. The expansion in top-line was largely due to the inclusion of MRT2 project as well as the start of KVDT project. Furthermore, to note that back then, the Alex Corp job slowed down in 1Q17 pending the upgrade of the 500kV transmission line which was subsequently awarded in early February last year or 3Q17 in PESTECH’s financial period. On the other hand, the bottom- line was crimped by the abovementioned DPL adjustment in 2H18 while DPL for the previous financial periods were in construction stages, which recognised higher construction profits.

Contracts in hand offer 2-3 years earnings visibility. With the cancellation of East Coast Rail Link (ECRL), the KL-Singapore High- Speed Rail and Gemas-JB double track projects are the only two major electrification projects locally for PESTECH to participate, of which we think the contract sums are fairly huge should it be able to secure them. On the other hand, as the government is looking to upgrade the existing East Coast KTM line to replace the canceled ECRL project, PESTECH should stand a good chance of securing the project based on its track record on the West Coast KTM line. Meanwhile, its current order-book is estimated at RM1.57b which should keep it busy for at least the next 2-3 years.

Maintain OUTPERFORM. We reduce our FY19 earnings estimate by 13% on lower EPC operating margin to 14% from 15% previously while introducing our new FY20 forecast with earnings set to grow by 14%. At the same time, we expect no NDPS for FY19-FY20 as it preserves cash for business expansion. Post-earnings cut, new target price is reduced to RM1.95 from RM2.15 based on SoP valuation. Although 4Q18 earnings were disappointing, we believe it should be back on track from FY19 onwards. Thus, it remains an OUTPERFORM. Risks to our call include failure to replenish order- book and cost over-runs.

Source: Kenanga Research - 29 Aug 2018