Review

• Dagang NeXchange Bhd’s (DNeX) FY18 core net profit of RM33.8mn (-40.4% YTD) was grossly below expectations - accounting for merely 64% and 68% of ours and consensus’ full-year estimates respectively. Core profit in FY18 excludes amongst others, goodwill impairment of RM3.6mn recognized at the Energy division.

• The shortfall versus our forecasts mainly stemmed from: 1) unexpected surge in 4Q18 taxes, 2) prolonged delay in delivery of portable container system (PCS), and 3) weaker than expected earnings from the IT segment.

• To recap, in Jul-17, the Group secured a contract to supply 50 units of PCS (estimated value: RM25mn) to Petro Teguh. However, DNeX only managed to deliver one PCS as at mid-Dec 2018 due to delay in regulatory approvals. We estimate that the Group currently holds 41 PCSs that are either completed or under construction.

• The plunge in 4Q18 core profit to RM4.0mn (3Q18: RM10.3mn) was due to weakness in contribution from 30%-associate, Ping Petroleum. This was underpinned by the drop in crude oil price towards end-4Q18. Additionally, bottomline rout was exacerbated by a surge in taxes.

• Meanwhile, the steep decline in YTD profits was underpinned by deferral in uplift of oil from Anasuria field to mid-January 2019. To a lesser extent, higher finance costs on the back of increased borrowings was an additional drag to bottomline. The above more than offset stronger IT earnings on the back of: 1) consolidation of Genaxis Group, and 2) progress billings for the submarine cable installation and repair project in Indonesia.

• DNeX declared 4Q18 DPS of 0.5 sen (4Q17: nil), which brings FY18 DPS to 0.5 sen (FY17: 0.5 sen). This translates to higher FY18 payout ratio of 26% (FY17: 15%).

Impact

• Major changes to our forecasts include: 1) accounted for higher costs at the IT segment, 2) reduced contribution from PCS contract, 3) raised interest costs and effective tax rate, 4) raised lifting volumes at Anasuria, and 5) reduced orderbook replenishment at OGPC (Energy Segment). As a result, our FY19/20 forecasts are slashed by 21%/17%.

Outlook

• For the Energy segment, we are concerned that DNeX Oilfield Services (DOS) will face continued challenges to replenish its orderbook. This is underpinned by heated competition amidst a soft market. Additionally, prolonged delay in delivery of portable container system (PCS) solutions will be a drag on cashflows and result in earnings disappointments.

• Additionally, we are concerned of earnings risk for IT services providers with exposure to government projects. Given austerity measures by the new government, and as evident in other industries, we are cautious that contracts will be subject to review, re-tenders, and renegotiation. In a better scenario, even if DNeX manages to retain its contracts, there is risk of margin compression from renewals or revisions to less favourable terms.

Valuation

• We downgrade our IT sector target P/E for DNeX’s IT business to 9x (previous: 12x) in our SOP valuation. This is in-line with the sector-wide derating for the Group’s IT peers due to regulatory headwinds. On the back of this, and coupled with the cut in our earnings forecast, our SOP target price for DNeX is slashed to RM0.29 (previous: RM0.41). Therefore, we downgrade DNeX to Sell from Buy previously.

• Against the challenging backdrop as highlighted above, and coupled with multiple earnings headwinds, we cease coverage on DNeX.

Source: TA Research - 28 Feb 2019