2QCY11 results recap. Both downstream EPC companies under our coverage reported weaker results. Rotary Engineering Ltd (Rotary)'s 2QCY11 revenue fell by 27% YoY to S$153m (2QCY10: S$209m) and net profit by 26% YoY to S$10m (2QCY10: S$14m). PEC's revenue decreased by 19% YoY to S$101m (2QCY10: S$124m), but net profit plunged 64% YoY to S$3.5m (2QCY10: S$9.6m). Rotary announced an interim dividend of 1 cent for 1H11, while PEC declared dividends of 3 cents for financial year ended June 2011.
Review of operations. The decline in Rotary's net profits was attributable mainly to lower revenue recognition as its SATORP mega-project progressed from the engineering and procurement phases to the construction phase. For PEC, the decrease in revenue was due to fewer secured contracts and lower settlement claims. In addition, its bottom line was also hit by S$6.6m of losses from its JV and associates arising from unconfirmed claims for variation works during the quarter. In terms of gross margins, both companies reported improvements. Rotary's gross margins increased to 21% (2QCY10: 18%), while PEC's jumped to 30% (2QCY10: 23%) helped by the completion of additional projects.
Strong balance sheets. As of end of 2QCY11, Rotary was in a net cash position (S$98m in cash and S$63m in debt). Its annualized receivables turnover days stood at a high 279 days for 2QCY11 (1QCY11: 328 days) mainly due to the contractual terms for its SATORP mega-project. Management expects the figure to improve as the SATORP project approaches completion. As for PEC, the group holds a huge cash position of S$159m against only S$0.9m of debt, providing it the flexibility to seek acquisition opportunities when these arise. PEC's annualized receivables turnover days remained satisfactory at 47 days (1QCY11: 43 days).
Macro-economic headwinds. The recent worries over European sovereign debt issues and slow-down in the US economy has also led to greater uncertainty in the operating environment and volatility in the oil prices. Downstream EPC companies like Rotary and PEC are not directly affected by movement of oil prices, but may be affected if demand for infrastructure projects at petrochemical complexes and oil terminals falls drastically. We believe that the main risk for both companies is fewer contract wins over the next few quarters, although this is partially mitigated by the groups' order-books (Rotary: S$757m; PEC: S$300m). In terms of valuation, we continue to like PEC [BUY; FV: S$1.12] for its strong cash position (net cash: S$0.62 per share).
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