PEC Ltd - Hurt by associates (CIMB)

NEUTRAL Downgraded

S$0.89 Target: S$0.93

Mkt.Cap: S$227m/US$189m

Oil & Gas - Equipment & Svs

• Below; downgrade to Neutral from Outperform. 4Q11 earnings of S$3.5m (-64% yoy) is 43% below our expectation and 60% below consensus due mainly to losses from associates. FY11 earnings of S$32.1m (-28% yoy) form 92% of our number. Also below is its final and total DPS of 3.0cts (24% payout) vs. our 4.0ct forecast. Cutting associate contributions and revenue & margin assumptions, we lower our earnings estimates for FY12-13 by 25-28%. We also introduce FY14 numbers. Our target price falls to S$0.93 (from S$1.58), now based on 7x CY12 P/E, 20% below the 5-year peer average (previously 9x, 5-year peer average) to reflect weak sentiment on small-mid caps and heightened earnings risks. As a flat earnings outlook is counteracted by strong financials and undemanding valuations, we downgrade the stock to Neutral. We would re-visit the stock upon stronger-than-expected orders.

• Strong operations. FY11 was a strong operational year, with a 28% gross margin on revenue of S$406.8m (-13% yoy). As a result, operating cash flow was a healthy S$37.4m. Slower 4Q11 turnover of S$101.4m (-19% yoy) was compensated somewhat by higher gross margins of 30%, owing to project closures. PEC also met our order target for FY11, securing S$337m of orders. Order book was S$300m or 0.94x book-tobill.

• Culprit was losses from associates. The positives were undone by a hefty S$6.6m provision for its Audex-Verwater JV, stemming from unclaimed variation orders for a €118m (S$226m) Rotterdam project. Though contributions from this project were weaker than expected throughout FY11, we were still caught by surprise by the kitchensinking in 4Q11. We understand that the provision should be sufficient. With engineering and procurement largely completed, the project is mid-way in the construction phase and should be completed by early 2012.

• Watch for erosion in maintenance margins. Another negative was the slippage in maintenance margins to 17.8% from the 22.7% average of the past three years. Management attributes this to competitive pressures. Maintenance is PEC’s edge and diminishing profitability here is a concern. We temper our maintenance gross margins to 20% (from 22%).

• Muted outlook. We project S$350m of new jobs annually, sustaining its annual revenue run rate at S$400m-450m. This results in a flat earnings outlook.