Rotary Engineering Ltd - Upgrade to BUY - Attractive entry point (OCBC)

Upgrade to BUY

Previous Rating: HOLD

Current Price: S$0.585

Fair Value: S$0.66

S$110m contracts win. Rotary Engineering (Rotary) recently announced it has secured S$110m worth of contracts between Jul and Sep 2011. The wins include a "multi-million contract" from Chang Chun Group, a Taiwan-based petrochemical company, to undertake construction of a chemical plant on Jurong Island. Besides the Chang Chun deal, the group has also won 10 other contracts in Singapore, including a S$13m EPC tankage project for a power plant project by Bangaloreheadquartered infrastructure company - GMR Group. Over the past few years, Rotary has been participating in a number of overseas projects, most notably in the Middle East region. With the recent wins, we believe that Rotary remains competitive in Singapore context even as it pursues global aspirations.

Mega-deals needed. Compared with average quarterly revenue of about S$155m (over the past eight quarters), we believe that Rotary will need to secure larger EPC contract in order to replenish its order-book meaningfully. We examined the group's order-book trend and noted that it has been trending downwards since 3Q09 (end-2Q11: S$757m; end-3Q09: S$1.4bn) when it won the US$745m contract from SATORP to build a refinery tank farm at Jubail, Saudi Arabia. For future mega-contracts, we believe they may emerge from the Middle East region (i.e. UAE and Saudi Arabia), where the level of oil and gas activities remains high and is relatively less affected by political unrest. In addition, Rotary could leverage on its successful execution of the SATORP project.

Start accumulating. Year-to-date, Rotary's share price has fallen by 43% compared to STI's 17% decline. We believe that the market is increasingly pricing in a recession and overly punishing the stock for its declining order book. Despite the decline, current order book (S$757m) would also still provide earning stability over the next 12 months. Beyond FY12, we believe its order-book should remain at S$700m-S$1b, of which a majority would come from Middle East projects. Its marketcap to order-book ratio at 0.53x (close to one standard deviation below its long-term average) is not excessive. Thus, we believe that the current price (at 6x PER and 1x PBR, also about one standard deviation below their respective averages over the past 5 years) is well-priced for upside. Long-term investors willing to accumulate the stock now will also receive 6% yield for bearing the risk, assuming the group continues to pay dividends at 40% earnings. Upgrade to BUY with fair value estimate unchanged at S$0.66. The key risks include worsening geopolitical risk across the Middle East region, a sharp cut in capex by oil companies and project execution risks.