INVESTMENT HIGHLIGHTS

• Deleum Bhd’s 2QFY19 earnings contracted by -5.6%yoy to RM8.7m

• ICS segment staged a turnaround with a PBT of RM8.7m

• Oilfield Services segment recorded LBT of -RM2.6m

• FY19-20F earnings estimates lowered by -13.2% and - 4.4% respectively due to margin compression

• Downgrade to NEUTRAL with a revised TP of RM0.84 per share

Earnings contracted despite strong revenue. Deleum’s 2QFY19 earnings contracted by -5.6%yoy to RM8.7m. This brings its 1HFY19 earnings to RM11.5m which makes up 32.8% of our and 28.8% of consensus’ full-year FY19F earnings estimate respectively. The weaker earning was mainly attributable to: (i) downward pressure on margins and; (ii) less favourable exchange rate of MYR to USD which has resulted in a net foreign exchange loss of RM1.9m as opposed to a net gain of RM0.8m in the same period last year. That said, revenue surged by +52.3%yoy during the quarter driven by higher revenue contribution coming from its Integrated Corrosion Solutions segment which stems mainly from its maintenance, construction and modification (MCM) project.

Power & Machinery. Segment revenue grew by +20.8%yoy due to higher work orders secured for exchange engines, valves and flow regulator services and higher revenue contribution from retrofit projects due to increase in project hardware deliveries. However, this was offset by the weaker work orders for turbine parts and repair, decrease in commission income earned on oil and gas projects and lower sales from third party and other ancillary services. Meanwhile, profit contracted by -44.5%yoy due to unfavourable change in sales mix, downward pressure on margins as well as; unfavourable exchange rate.

Oilfield Services. Segment revenue increased by +27.4%yoy due to stronger work orders from well intervention and enhancement services as well as increase in slickline services work orders in the East Malaysia region. However, this was offset by lower slickline activities in West Malaysia region. Segment profit fell to a loss during the quarter to -RM2.6m due to downward pressure on margins, losses from its overseas slickline operations as well as; adverse results in Production Optimisation and Flow Assurance (POFAS) operations.

Integrated Corrosion Solutions. Segment revenue surged by +168.1%yoy to RM76.2m (from RM47.8m in 2QFY18) due to the robust activity levels from its ongoing projects with higher sales revenue generated from the MCM services. Additionally, there is also a pick-up in the sales from its Sponge-Jet Blasting business following the renewal of Pan Malaysia Painting and Blasting Contract (PMPBC). The segment has also finally staged a turnaround during the quarter with a profit before tax of RM8.7m (from -RM2.9m in 2QFY18) which was mainly due to better sales mix and higher margins earned from is MCM and PMPBC contracts.

Impact on earnings. We are lowering our FY19-20F earnings estimates by -13.2% and -4.4% to RM30.3m and RM37.3m respectively as we opine that margin compression on its P&M and OS segments as well as; challenging operating environment for its OS segment will continue to drag earnings.

Downgrade to NEUTRAL. Post-earnings adjustments, we are downgrading our recommendation on Deleum to NEUTRAL (from BUY previously) with a lower target price of RM0.84 per share (from RM1.17 previously). Our TP is premised on PER20 of 9.0x pegged to EPS20 of 9.3sen. We opine this is fair given that we do not foresee the margin compression for two of its segments i.e; Plant and Machinery as well as; Oilfield Services to recover in the near future. Furthermore, its orderbook replenishment has been slower-than-anticipated which results in lower future earnings visibility. That said, we opine that Deleum’s niche in providing slickline services, turbine repairs and integrated corrosion solutions will remain as its key strength going forward which would place it at the forefront to win future contracts in these areas.

Source: MIDF Research - 23 Aug 2019