Tat Hong Holdings Ltd - Limited downside from China risks (OCBC)

Maintain HOLD

Previous Rating: HOLD

Current Price: S$0.81

Fair Value: S$0.82

Rising China property risks? Standard and Poor's (S&P) recently cut its outlook for China's real estate development sector from "stable" to "negative", citing increased pressures on inventory and sales. The credit rating agency also said that further government curbs may lead to rating downgrades next year. Earlier, the People's Bank of China increased the local banks' reserve ratio requirements for the ninth time since Oct 2010, bringing the official ratio for most large Chinese banks to 21.5%. We believe that further curbs are also likely to have an adverse impact on the Chinese property market as well as the construction / infrastructure industry.

Impact likely limited. By the same token, any slowdown in the construction / infrastructure industry could also affect heavy equipment suppliers like Tat Hong Holdings (Tat Hong). However, any impact on Tat Hong is likely to be limited, given that the contribution from China is still small. In FY10, we note that China accounted for 7% of Tat Hong's total revenue, up from 4% a year ago. We expect that portion to increase to just over 10% in FY11 on the back of strong revenue contribution from its tower crane business in China. In comparison, we believe that revenue contribution from Australia and ASEAN are approximately 60% and 30% respectively. Furthermore, contagion risk between China and other regions is also likely to be mitigated by the fact that the demand drivers for cranes in different regions are different.

Australia's recovery is key. On the other hand, Australia holds the key to an improvement in Tat Hong's business. Recall that the recent natural disasters in Australia led to disruptions in a number of infrastructure projects and damages to the company's plants and equipment. We believe that reconstruction activities should provide some earnings upside in the near term. In addition, growing energy demand is likely to fuel energy-related infrastructure projects in Australia over the medium term. However, as we highlighted in our previous report dated 7 June 2011, actual construction work may come through later rather than earlier due to damaged equipment and the lengthy planning / tender process.

Maintain HOLD. In any case, we have already factored in slower growth for its heavy tower crane business in China; we further believe that any sharp contraction looks unlikely as the government remains committed to improving the nation's infrastructure. As such, we maintain our HOLD rating with a fair value estimate of S$0.82, based on 11x forward EPS. Potential catalyst could come from higher growth from Australia, although the actual timing of recovery remains uncertain.