Tat Hong Holdings Ltd - Maintain HOLD with lower fair value of S$0.59 (OCBC)

Maintain HOLD

Previous Rating: HOLD

Current Price: S$0.655

Fair Value: S$0.59

Weakness in Australia construction sector. According to Australia Industry Group (AIG)'s recent findings, the downturn in the country's construction industry continues to deepen in Aug 2011, driven by a further fall in activity and sharp reduction in new orders. The seasonally adjusted AIG Performance Construction Index declined 4.0 points to 32.1, marking the 15th consecutive month that the index has fallen below the critical 50 points, separating between expansion from contraction. We suspect it may take some time before we see a recovery in Australia's construction sector. As the country is a key market for Tat Hong Holdings (TAT) and accounted for more than half of the group's revenue (FY10: 59%; FY11: 54%), delays in its recovery could have a substantial impact on TAT’s near-term financial performance.

Increased activity in energy/resources projects. On the other hand, our channel checks indicate increased level of activity in a number of oil & gas and mining projects. In particular, the LNG market in Australia is attracting considerable degree of interest. However, many of these projects are at the conceptual or design stage and construction has yet to commence. But once these projects move into the construction phase, TAT should be able to benefit from increased demand for its cranes and other equipments as it has an established presence there through its Tutt Bryant subsidiary.

AUD has strengthened against SGD. Meanwhile, AUD has appreciated against SGD by about 5% over the recent quarter. This may result in translation gains, mitigating the weakness in the Australia market. We estimate that for every 1% gain in AUD, TAT could see a 0.5% to 0.6% gain in revenue. However, unless AUD continues to strengthen at the same or faster pace for the rest of the year, any translational gains on the group's bottom line are likely to be negligible. For transactional currency risk, we believe that TAT hedges 50% to 100% of the risk through the use of derivative contracts.

Maintain HOLD with lower FV of S$0.59. Due to the lack of clarity in Australia's construction outlook and the uncertainty in the timing of its recovery, we put off adjusting our estimates for now and await clearer signs of a recovery. However, we are lowering our valuation peg from 11x to 9x (one standard deviation below its long-term average) on blended FY12/FY13 EPS, in line with the weaker overall market. Maintain HOLD with a lower fair value estimate of S$0.59.