Rotary Engineering - 2H may not be as strong as thought (DBSVickers)

NEUTRAL Downgraded

S$0.81 Target: S$0.90

Mkt.Cap: S$460m/US$382m

Oil & Gas - Equipment & Svs

• Below; downgrade to Neutral from Outperform. Forming 14% of our FY11 forecast and 15% of consensus, 2Q11 net profit of S$10.2m (-26% yoy) is 50% below our expectation because of lower-than-expected turnover. 1H11 net profit of S$15.5m (-44% yoy) forms 22% of our FY11 number. An interim dividend of 1ct (37% payout) has been declared, as expected. We cut our earnings estimates for FY11-13 by 11-30% on lower revenue and margin assumptions. Our target price accordingly drops to S$0.90, still based on 9x CY12 P/E (5-year peer average), from S$1.26. As 2H11 is unlikely to be as strong as previously thought, we downgrade the stock to Neutral. On the other hand, a projected 5% dividend yield and the stock’s YTD decline of 21% should limit downside risks. We would re-visit the stock on stronger-than-expected orders.

• 2H11 unlikely to be as strong as thought. 2Q11 turnover dropped 27% yoy to S$153m as the landmark S$1bn SATORP project shifts from the engineering & procurement stage to construction. In the procurement phase, there could be spikes in quarterly revenue from the delivery of materials (as seen in 2Q10). However, turnover is now expected to stabilise in the construction phase. We previously anticipated stronger revenue from construction milestone completions. In addition, a slower-than-expected ramp-up of the Fujairah Oil Terminal project (engineering to start in 3Q11) points to a softer 2H11.

• Other highlights. Gross margins expanded 3% pts qoq to 21% on positive cost variances upon project closure. 1H11 cash operating cash outflow was S$30m due to higher working-capital requirements. Consequently, net cash declined to S$35m (6cts/share) from S$96m (17cts). Nonetheless, we expect receivables to reverse in 2H11 as the group receives payment from SATORP.

• Slower-than-expected orders, though a mega-Saudi job has emerged. Order book was S$757m, with the group announcing S$70m worth of jobs from Jurong Island. We understand that prospecting for a Turkey tank-farm project has stopped due to project-feasibility issues. However, Rotary has been prequalified for two tank-farm packages for the US$26bn Ras Tanura integrated project in Saudi Arabia. Bids open in Oct 11 and the results could be known by early 2012.