We remain positive on Dagang NeXchange Bhd’s (DNeX) prospects despite recent weak sentiment towards IT players arising from fear over termination of government projects. This is because we believe that 1) DNeX has strong IT expertise to weather through scrutiny, and 2) recovery in crude oil price should improve associates’ contribution. That said, we acknowledge DNeX faces persistent delays for the PCS contract and new IT contracts secured may carry lower margin. Thus, we lower our FY18/19 forecast by 14.9%/5.8%, but raised FY20 forecast by 2.3%. Furthermore, we lower PER valuation of IT segment to 12x CY19, and arrive at lower SOP target price of RM0.41.

Enhancing Ping’s Production

Management shared that 30%-owned Ping Petroleum will continue its effort in enhancing production of Anasuria cluster by strategically increasing the number of wells. The productivity enhancement initiatives will focus on existing producing fields i.e. Guillemot, Teal, Teal South and Cook. Ping aims to boost production from Anasuria by circa 15% next year. However, management noted that no lifting will be performed for Anasuria in 4Q18, leaving total FY18 lifting at 4 times (against earlier guidance of 5 liftings). We understand that 4Q18 lifting will be delayed until January 2019. Consequently, it is anticipated that there will be 5 liftings in FY19. That said, its Avalon field is expecting first oil in mid-2019, whilst production facilities will be completed in mid-2020. Despite large capex for ongoing development, Ping may potentially pay out dividends, given strong cashflows from Anasuria’s operations.

Slow Progress on PCS Contract

To recap, OGPC secured a contract to supply Portable Container System (PCS) to Petro Teguh last year. Management noted that delivery is way behind schedule (YTD: only one PCS delivered), primarily due to delays arising from regulatory approval. We understand that there are currently 41 PCSs that are either completed or under construction. Management hopes to deliver 7 units before end-FY18, with the balance to be delivered in 1H19. Owing to the persistent delays, DNeX decided to take a more conservative approach via temporary halt of further PCS orders prior to delivery of the 41 units. While slower-than-expected delivery is undesirable for its cash flow, we note that DNeX’s task under the contract is only to supply the PCS. Therefore, we believe that DNeX will not incur any penalties for the delays.

IT Portfolio Mix: Finding a New Norm

Recall that IT segment EBIT margin has fallen to 14.6% in 3Q18 (QoQ: -3.6 pts. YoY: -19.0 pts). DNeX revealed that the decline in margin was due to:- 1) increasing number of newer contracts with lower margin, 2) increase inmanpower, and 3) higher expenses incurred to stay competitive in the market. On a brighter note, revenue of the IT division has risen significantly, recording RM152.8mn in 9M18 (+52.7% YoY). We note that the NSW contract remains the main revenue generator of DNeX’s IT division.

VEP System: Business as Usual

Management noted that DNeX currently operates the Vehicle Entry permit (VEP) system as a subcontractor of TCSens. Thus, any forms of litigation with the government will involve TCSens. Nevertheless, DNeX shared that the group has helped the government to collect over RM200mn since commencement of the VEP-RC contract. In addition, DNeX updated that VEP-RFID (encryption of RFID on incoming Singaporean vehicle) is expected to move into pilot acceptance testing beginning 1st January 2019. Based on published data of Singapore’s Land Transport Authority, Singapore has over 600k units of private cars.

Outlook

We expect DNeX to take a step back from M&A activities and focus on growing and consolidating its current businesses. The Group will leverage on the expertise of its subsidiaries i.e. Genaxis, DNeX Telco and DNeX RFID in securing and executing contracts. Additionally, DNeX’s long term outlook seems secured underpinned by 1) SEALNET trade facilitation system and 2) further development of Anasuria and Avalon hub by Ping Petroleum.

Impact

We make the following changes to our earnings model:

1. Reduced margin of IT segment given the change in portfolio mix

2. Lowered our PCS delivery assumption

3. Increased FY19/20 production volume of Anasuria Thus, our FY18/19/20 forecast is adjusted by -14.9%/-5.8%/+2.3% respectively. The decline in absolute earnings in FY20 is mainly from the loss of NSW monopoly and assumption of no new contracts.

Valuation

We lower DNeX’s TP to RM0.41 (previous: RM0.51) based on SOP valuation after factoring weaker earnings forecasts and lower target of 12x CY19 PER (previously: 16x CY19 PER) for DNeX’s IT segment. This is due to poor market sentiment toward government vendors amidst contract termination concerns. Nevertheless, we maintain BUY on DNeX underpinned by 1) DNeX’s strong IT expertise will enable it to weather through scrutiny and 2) expectation of crude oil price recovery.

Source: TA Research - 17 Dec 2018