• Healthy track record with positive earnings and improving profit after tax margins

• Despite the decline in demand for offshore cranes, Favco’s orderbook is cushioned by the heightened order for tower cranes

• Favelle Favco is in a net cash position with consistent dividend payouts

• We initiate coverage on Favelle Favco under the Bursa Mid and Small Cap Research Scheme (MidS) with NEUTRAL recommendation and target price of RM2.92

Improving profit margins… Favelle Favco Bhd (Favco) is a profit making company, with improving profit after tax margins. This is despite the tough operating environment stemming from low crude oil prices that led to a sluggish oil and gas capex rollout. The profit after tax and minority interest margin expanded by +1.9ppts in 2016 compared to 2015.

…due to better operating efficiency. Historically, the previous time crude oil price was at the current low levels was 9 years ago in 2008. But compared to 2008, Favco’s earnings have since improved with a CAGR of +14.6% and its profit after tax margin has expanded by +9.0ppts. Supporting the positive earnings and improving profit margins is the increase in operating efficiency with distribution costs being maintained at below 2% of revenue since FY2011.

Offshore cranes demand is dwindling… Favco has a huge exposure in the oil and gas sector via its offshore cranes division. However, the slump in crude oil prices since mid-2014 signifies a major decline in its offshore crane business. This is evidenced by a lower orderbook from an all-time high of RM1,091m (as of 18 November 2014) to the current RM612.1m (as of 17 May 2017). Currently, the industry’s capex plans are still subdued due to volatile crude oil prices.

…but tower cranes cushion the fall. Nonetheless, the decline in offshore crane demand is cushioned by heightened order for tower cranes. The tower cranes are mainly used in the construction industry and the onshore wind turbine market. While offshore cranes still occupy the bulk of the orderbook at 63.7%, tower cranes and other cranes now take up 36.3% of the orderbook compared to only 10.0% in mid-2014. The current orderbook of RM612.1m could last until early 2018. Therefore, the shift in Favco’s orderbook mix could cushion its revenue stream from any adverse impacts from the oil and gas industry.

Net Cash Company. Favco has been in a net cash position since FY2010 given the company’s modest capex requirement. As at FY2016, Favco’s net cash position stands at RM340.8m which is more than 50% of the company’s market capitalisation. Such net cash position has enabled Favco to service its debt obligations over the past five years. This also ensures a consistent dividend payout to its shareholders.

Consistent dividend payout. For the past four years, Favco’s dividend payouts have been steady at ~30%. Going forward, we are expecting Favco to maintain its payout ratios at around 30% supported by the current net cash position of the company.

KEY RISKS

Lower dividend payout. Should there be any M&A exercises which involve cash outlays, the company may not be able to sustain its dividend payout at ~30%.

Litigation risk due to nature of business. Cranes manufacturers operate in an environment where quality and reputation are key considerations, hence any untoward accidents may weaken its brand and demand.

Slowdown in orderbook due to infrastructure headwind. Despite experiencing a slowdown from the O&G sector, any unforeseen headwind in the infrastructure segment can affect Favco’s orderbook replenishment.

VALUATION

Initiate with NEUTRAL. We initiate coverage on Favelle Favco under the Bursa Mid and Small Cap Research Scheme (MidS) with a target price of RM2.92 per share. Our target price is based on EPS18 of 34.3sen pegged to a PER18 of 8.5x. The main favourable fundamental attributes of Favelle Favco are (i) shift in orderbook mix to cushion downfall, (ii) net cash position, and (iii) consistent dividend payout translating into a reasonable dividend yield.

Source: MIDF Research - 30 Jun 2017