PEC Ltd - Lack catalysts (DBSVickers)

HOLD S$0.835 STI : 2,765.74 (Downgrade from BUY)

Price Target : 12-Month S$ 0.90 (Prev S$ 1.52)

Reason for Report : Revision of earnings forecasts; cut in TP; change in recommendation

Potential Catalyst: Contract wins

DBSV vs Consensus: Below on lower contract wins assumption

• FY11 below expectations on losses from associates.

• Project execution remains sound; offset margin pressure for Maintenance services.

• Undemanding valuations but catalysts lacking; downgrade to HOLD, lowered TP to S$0.90.

FY11 below on associate/JV losses. PEC posted FY11 headline PATMI of S$32.1m; excluding fair value gains on derivatives, core PATMI was S$29.5m, 19% below expectations. The variance was due mainly to JV/associates losses of S$6.6m (vs. expected S$1.1m profit) arising from unsettled variation orders on the JV’s Rotterdam project. A final and special DPS of 3.0 Scts was declared (FY10: 4.0 Scts).

But project execution remains sound. Group gross margins remained firm at 27.8% (+1.4ppt y-o-y). Maintenance division reported lower gross margin of 17.8% (-5.6ppt y-o-y) due to competitive pricing. This was offset by the Projects division, which posted gross margins of 31.5% (+4.0ppt y-o-y) on project completions and solid execution.

FY12/13 order wins kept at S$300m. On the back of limited order pipeline visibility and an uncertain macro outlook, we keep our FY12/13 order wins assumption of S$300m each (vs. FY11: S$337m). End FY11’s order backlog of S$300m translates to book-to-bill of 0.98x.

Undemanding valuations, but catalyst lacking. Downgrade to HOLD, TP S$0.90. We cut FY12F by 9% on reduced Maintenance margins; FY13F is raised by 11%, on sustainable Project margins of 26%. We believe delivery of earnings growth is key value driver for the stock going forward. As such, we peg PEC’s TP on 7x FY12 PE, in line with its historical average (prev 6x PE plus net cash). Despite the support of its net cash of S$0.62/share, upside potential is also limited by the lack of visible catalysts, muted earnings growth, and limited visibility on order flows. As such, we downgrade PEC to HOLD from Buy previously.