• Malaysia Marine and Heavy Engineering's (MMHE) Heavy Engineering segment expected to remain under strain

• Company to diversify revenue stream away from Heavy Engineering into downstream related jobs

• East Yard could be repurposed for other non-core activities

• Construction of 3rd dry dock could cost up to RM500m

• Maintain SELL with unchanged TP of RM0.56 per share

Heavy Engineering segment under strain. MMHE’s heavy engineering segment has been under strain for more than two years as large offshore fabrication jobs become scarce. This has caused overall group revenue to decline from RM2.7b in FY14 to only RM1.2b in FY16. Fortunately, the company’s Marine segment, involving the repair and refurbishments of marine vessels is keeping the company afloat during these trying times.

Transforming the Heavy Engineering segment. Due to the continuous slowdown in heavy engineering jobs for the next few years, the company is actively seeking to steer away from heavy engineering into other services such as hook-up and commissioning, plant turnaround and shutdown activities, manufacturing of process modules and other downstream engineering works, which the company currently has the necessary existing expertise in.

Repurposing the East Yard. Due to the lack in heavy engineering works, the company’s 116-acre East Yard could be repurposed for other revenue generating activities. These could potentially include the manufacturing of the KL-Singapore high speed rail, leasing of land for warehousing needs and acreage for vessel lay-ups.

Construction of 3rd dry dock. To complement the company’s shift in business focus to the Marine segment, the company could potentially be building a 3rd dry dock to accommodate larger future orders. The 3rd dry dock would costs an estimated RM500m to build and could be funded via 20% cash and 80% borrowings (Sukuk Murabahah programme of RM1b where RM20m was issued in September 2016).

Potential merger and acquisition for MMHE. While the company is a prime candidate for merger and acquisition from a balance sheet standpoint (cash per share of 41sen) and low price-to-book ratio (approximately 0.6x), we believe that the bane of having a large idle yard space makes MMHE unattractive. However, because the company’s lifeline currently hinges on its Marine segment and future ventures into the downstream engineering segment, we believe that MMHE could be forming alliances, joint-venture partners and also collaborations with existing experts to enter new niche business segments.

Weak orderbook recognition of FY17. Current heavy engineering orderbook stands at RM1,058.6m. From the current job profile and work orders, approximately only 30-50% of the order backlog will be recognised in FY17. The company further estimates that the revenue from the marine segment will match that of FY16 at approximately RM400-500m per year – the company’s current dock capacity.

Maintain Sell. We do commend the company’s effort in trying to diversify its income stream, without straying too far from its core competencies. However, from a stock trading standpoint, we do not foresee any near-term re-rating catalyst which would cap stock price appreciation in the immediate term. As such, we are maintaining our SELL recommendation with an unchanged target price of RM0.56 per share. Our target price is based on our house midcap oil and gas service provider target PER of 14x pegged to EPS17 of 4sen. The focus for the company moving forward now is on the expansion of the Marine segment and also jobs from within RAPID.

Source: MIDF Research - 30 Mar 2017