Yongnam Holdings Ltd (CIMB)

OUTPERFORM Maintained
S$0.26 @13/06/11
Target: S$0.40
Construction

All systems in place

• Stronger recognition this year. YNH’s contract wins had picked up strongly in 2Q11, with the group securing more than S$190m worth of contracts or 40% of our target for this year. Coupled with profit margins which had been sustained over the four quarters of 2010 (with a positive surprise in 1Q11), we believe YNH is on track to meet our FY11 earnings target. No change to our EPS estimates or target price of S$0.40, still based on 8x CY12 P/E, a 20% discount to its mid-cycle multiples. We also like YNH’s undemanding valuations against peers, at 5.2x CY12 P/E vs. the peer average of 7.6x. We expect stock catalysts from contract wins for projects such as the MRT Downtown Line and structural steelwork projects in the Middle East.

• On track to meet FY11 earnings target. Although 1Q11 turnover only accounted for 17.5% of our FY11 forecast, we see two reasons for remaining optimistic on our net profit target of S$60m. First, contract wins had picked up strongly in 2Q11, with the group securing more than S$190m worth of contracts in that quarter, or 40% of our target for this year. Second, profit margins have been both strong and sustainable for 4-5 quarters, with a positive surprise in fact in 1Q11.

• Order-book renewal. We estimate that YNH is bidding for S$1.2bn worth of projects this year. The outlook in Singapore remains underpinned by numerous opportunities in the civil engineering space. The Middle East is another market with considerable infrastructure spending plans. We believe if the political situation stabilises there, construction firms like YNH could stand to reap major benefits.

On track to meet FY11 earnings target

During its 4Q10 results announcement, management had guided for earnings recognition of S$270m (60% of its S$450m order book as at 31 Dec 10) for 2011. 1Q11 turnover represents 28% of that S$270m amount. This is consistent with 1Q revenue which typically makes up 23-28% of full-year numbers (cf. FY09-10). An apparent lack of contract flows in the first quarter of this year (only a S$24m contract announced late in 1Q11) implies that the turnover of S$75m was derived mainly from an existing order book. This further implies that work on existing projects is proceeding well, and that the other 72% of management’s guidance would pan out by end-2011.

Although 1Q11 turnover only accounted for 17.5% of our FY11 forecast, we see two reasons to remain optimistic. First, contract wins had picked up strongly in 2Q11, with the group securing more than S$190m worth of contracts in that quarter. This figure makes up for 40% of our full-year target. We expect stronger revenue recognition for the remaining nine months of FY11. Second, profit margins have been both strong and sustainable for 4-5 quarters, with a positive surprise in fact in 1Q11.

Expect stronger revenue recognition. YTD, YNH has won S$217m contracts, of which 89% was secured in the second quarter of 2011. With these contracts, quarterly revenue in the next three quarters of FY11 is likely to surpass 1Q11 levels. Assuming that existing projects continue to make steady progress, we see upside to quarterly revenue from new contracts won in the year.

Strong and sustainable margins. Even if full-year revenue falls short of our target, we believe persistent margin strength could make up for the shortfall. Throughout FY10, YNH’s net profit margins had been consistently well above those of the corresponding quarters in FY09. This was attributed to: 1) a shift in its revenue mix to the highermargin specialist civil engineering segment; and 2) better margins in the structural steelwork segment. A spike in 1Q11 gross margins came as a pleasant surprise to us, from an average 28.6% in FY10 to 33.2%; lifting net profit margins to 20% in the quarter. For the sake of prudence though, we have kept our gross and net margin assumptions of 26.3% and 14.1% respectively for FY11. Judging from the strength of its margins in the past year, any revenue shortfall could be made up by potential margin upside during the year.

Order-book renewal
Promising projects. We estimate that YNH is bidding for S$1.2bn worth of structural steel (67%) and specialist civil engineering projects (33%) this year. With its shift in focus to specialist civil engineering projects, these projects now represent a third of the total value of its bids, up from only 21% in 2010. In contrast, structural steel projects now account for less than 70%, from almost 79% in 2010. The shift is consistent with the emergence of abundant specialist civil engineering opportunities in the domestic market after the Singapore government unveiled its transport system master plan to “make public transport a choice mode”.

Good domestic outlook for specialist civil engineering. To date, the group has won S$73m worth of specialist civil engineering projects. With contracts for the proposed 21km-long, 16-station MRT Downtown Line 3 under bidding, we may see some contract wins in 2H11. If successful, there would be little slack time for YNH’s specialist civil engineering team, as the government has given the go-ahead for the construction of the North-South Expressway at a cost of S$7bn-8bn, for completion by 2020. This is in addition to plans for two new MRT lines: Thomson Line and Eastern Region Line.

Don’t discount Middle East yet. The Middle East is a big market with good prospects, interrupted by recent political turmoil. Prior to the disturbances, countries in the region had already announced huge infrastructure spending plans which would likely benefit construction firms like YNH. On the back of rising demand for power and utilities in addition to transport infrastructure which is in need of overhauling, Saudi Arabia will be pouring US$400bn into infrastructure projects. New projects are designed to improve the efficiency and quality of the cities in the kingdom and facilite access to these cities from the surrounding areas. Qatar is another market which offers potential over the medium term, catalysed by the country's hosting of the 2022 FIFA World Cup. According to a report by Business Monitor International, some US$80bn could be spent preparing the country for the World Cup. Even prior to winning hosting rights for the tournament, Qatar had already wanted to invest US$20bn in tourism, including US$3bn-4bn in new stadiums regardless of the outcome of its football bid.

We estimate that Middle East projects could make up 35% of the group’s projects. One structural steel project is the Muscat Airport Terminal Building in Oman. In the event of a contract win, risks should again be borne largely by the main contractor, while payments to YNH would be made on a monthly progress basis.

Valuation and recommendation
Maintain Outperform. No change to our order-book assumptions, EPS estimates or target price of S$0.40, still based on 8x CY12 P/E, a 20% discount to its mid-cycle multiples. We also like YNH for its undemanding valuations against peers, at 5.2x CY12 P/E vs. the peer average of 7.6x. We expect stock catalysts from contract wins for projects such as the MRT Downtown Line and structural steelwork projects in the Middle East.