CSC Holdings: A disappointing start (DMG)

(NEUTRAL, S$0.13, TP S$0.12)

CSC’s 1QFY12 earnings was below expectations despite a 8.8% YoY growth in revenue, coming in at S$0.8m, due to margin erosion from higher costs and projects delays/interruption. While order book is strong, standing at S$200m currently and projects aplenty, margins may only pick up in 2HFY12. Thus, we have lowered our FY12 and FY13 earnings forecast by 68.3% and 62.6% to S$5.3m and S$8.6m respectively, to reflect the slower than expected pick-up in gross margins. Downgrade to NEUTRAL with a lower TP of S$0.12 (previously S$0.19), based on

0.85x P/B - the level CSC was trading at post the 2005-2007 construction up-cycle (previously 12x FY12/FY13 blended P/E).

1QFY12 results below expectations. Despite 1QFY12 revenue rising 8.8% YoY to S$84.5m (attributable to an increase in demand for foundation engineering services), CSC turned in a

profit of S$0.8m (down 74.6% YoY), due to margin erosion arising from higher labour costs and interruption/delays in certain projects that was not within the company’s control. As a result, gross profit margin (gpm) dropped from 12% in 1QFY11 to 6.6% this quarter.

Pipeline of projects strong, but at what margins? In 1QFY12, CSC secured >S$100m worth of foundation contracts in Singapore and Malaysia. Order book remains strong, standing at S$200m currently and would be fulfilled over the next six months. In addition, the company is in talks to carry out foundation works at Jurong Island and Tuas and negotiating with main contractors for MRT Downtown Line 3 (DTL3) projects. This validates our view that there is a strong pipeline of projects out there. However, we understand that for those projects secured to date, they are still reflective of the competitive pricing environment. Thus, it may only be in 2HFY12 before we see a pick-up in margins.

Lowering margin assumptions, downgrade to NEUTRAL. With CSC’s strong track record in MRT projects (it clinched four out of 12 MRT stations along the DTL2), it is likely to secure some projects from the upcoming DTL3. However, we cut our FY12 and FY13 earnings to S$5.3m and S$8.6m, largely on the back of a 6ppt reduction in gpm to 8% and 9% respectively (last seven years’ average was 15.5%).