KEY INVESTMENT HIGHLIGHTS

• Tiong Nam is investing RM200.0m for capital expenditures

• Expected to add more than 10% capacity to warehouse segment to reach 6.0m sqft marks

• The funding for CAPEX is too large to be funded internally

• Additional RM200.0m debt incurred will increase the group net gearing ratio to 1.72x from 1.43x

• FY20-21F earnings maintained for now

• Maintain SELL with an unchanged TP of RM0.31 per share

Capex for new warehouses. Based on recent news flows and a statement from the group, Tiong Nam is investing roughly RM200.0m worth in capital expenditures. The spending is designated for the construction of three new warehouses and expansion of its truck fleet. The new warehouses are located in Senoko, Singapore, Pasir Gudang and Kempas in Johor. An estimated 90% of the CAPEX will be earmarked for the construction of 190,000 sqft warehouse in Singapore. The remaining 10% is being set aside for the smaller warehouses in Johor and new trucks for the group.

Current capacity of Tiong Nam. Tiong Nam logistics services are supported by a fleet of circa 3,600 transportation vehicles (prime movers, box and refrigerated trucks, low-loader, delivery vans and others). The group logistics services consist of 83 regional warehouses and distribution centers across ASEAN countries with total capacity of 5.4m sqft. This additional capex spending is expected to add more than 10% capacity to warehouse segment to reach 6.0m sqft marks. The group expected these warehouses to be completed in FY22.

Double edged sword. The details on the capex funding remains unclear as we wait for further delineation from the group. However based on recent financial result, Tiong Nam cash and equivalents stood at ~RM10.50m with total borrowings circa RM1.0b. In additions, their interest expense as of FY20 was RM49.30m (average cost of debt circa 4.8%). Based on our observation on cash balances and borrowings size, we believe, the funding for CAPEX is too large to be funded internally. Hence, based on our preliminary calculation, additional RM200.0m debt incurred will increase the group net gearing ratio to 1.72x from 1.43x, an increase of 20%. To note, certain borrowings for Tiong Nam are subject to covenant that the gearing ratio of the group shall not exceed 1.7:1. Having said that, this capex decision might be a double edge sword as it can improve the company’s topline, yet potentially hemorrhage its already thin earnings. Noteworthy to highlight, Tiong Nam’s interest expenses for FY19 and FY20 were RM47.21m and RM49.30m, or ~83% or 81% of its operating profit. This demonstrates huge financial commitment to service its existing debt, not to mention additional debt obligation, if materializes.

Earnings impact. We opine that it is too early to quantify the expected RM200.0m in capex investment has on Tiong Nam’s bottomline. Furthermore, our channel checks reveal that it will take a while (an estimated eight (8) years) for a warehouse of such size and investment to break even. Hence, while the new warehouses and addition to its truck fleets with undeniably assist in lifting earnings; we do not expect a speedy contribution coming from the investment any time soon especially with the expected high interest expense to be incurred in the future should the investment go through. Therefore, we are maintaining our FY21-22F earnings estimates at this juncture.

Target price. We are maintaining our target price at RM0.31 per share as we wait for more disclosures on the CAPEX spending and it expected impacts. Our target price is based on sum-of-parts, consisting of: (i) its core logistics & warehousing business; (ii) its property development arm; (iii) hotel and dormitory segment and; (iii) its investment arm.

Maintain SELL. We opine that the company lacks rerating catalyst in the immediate term especially in the property segment with a remaining unsold GDV which is more than RM300m as of 30 December 2019. We believe that Tiong Nam will face difficulty in launching the Kota Masai project in time by 2HFY21 given that the majority of its property projects are located in Johor. Recall that in CY19, Johor saw a 10.4% decline in office occupancy rates, substantially higher than Penang that faced a 1.4% drop. Meanwhile, Johor accounted for most of the property overhang in Malaysia with 18,517 units as at 3QCY19 followed by Selangor and Kuala Lumpur with 7,226 and 5,170 units respectively.

We maintain our SELL call on Tiong Nam. A rerating catalyst would be: (i) a faster-than-expected recovery from Covid-19; and (ii) the pickup in Johor’s property market.

Source: MIDF Research - 28 Sept 2020