Midas Holdings: Waiting for light at the end of the tunnel (OCBC)

3Q11 earnings below expectations. Midas Holdings (Midas) reported its 3Q11 results with revenue exceeding our expectations, but net profit came in below despite the significant cut in our 3Q11 earnings estimate following the profit guidance issued on 9 Nov 2011. Revenue rose 4.6% YoY but fell 17.4% QoQ to RMB259.3m, while net profit plunged 59.8% YoY and 56.6% QoQ to RMB27.4m. For 9M11, revenue rose 23.3% to RMB869.7m, but net profit dipped 11.7% to RMB150.7m, meeting 80.8% and 70.5% of our FY11 forecasts, respectively. The lower sequential revenue was attributed to a delay in delivery schedule to its major customers. Net profit fell sharply on a YoY and QoQ basis due to higher production costs, a large spike in finance costs, higher effective tax rates and a share of loss from its 32.5%-owned associate Nanjing SR Puzhen Rail Transport (NPRT) amounting to RMB3.6m (versus a share of profit in both 3Q10 and 2Q11). Midas' current order book stands at ~RMB800m, versus RMB1.05b in 2Q11, while order book for NPRT was ~RMB7.9b.

Margins under pressure. Due to the aforementioned reasons, Midas' operating margin fell 4.6ppt YoY and 3.8ppt QoQ to 22.8%, while its net margin suffered a 16.9ppt YoY and 9.5ppt QoQ decline to 10.6% this quarter.

Possible railway spending cuts, but sector remains integral. While our positive long-term view on China's railway sector remains unchanged, we believe that a budget cut on railway spending by China's government seems plausible. There are media reports highlighting that China's annual investment on railway construction could be reduced to ~RMB500b per annum for the remainder of its 12th Five-Year Plan . Nevertheless we opine that this still represents significant spending on the sector, given its importance in fulfilling China's rising transportation needs and fuelling its economic development.

Maintain SELL. Midas' share price has tumbled 8.6% since it issued its profit guidance and is down 60.9% YTD. We cut our FY11/FY12 earnings forecasts by 13.6%/16.5%. Although current valuations do not appear expensive, with the stock trading at FY12F P/NTA of 0.7x, we believe that uncertainties surrounding China's railway sector in the coming months, rising cost pressures and higher finance costs could continue to weigh in on its share price performance. We apply a valuation peg of 9x to Midas' FY12F EPS as we expect the railway sector to recover in FY12. Maintain SELL with a revised fair value estimate of S$0.31, versus S$0.33 previously. Re-rating catalysts include a re-tendering of high-speed contracts by China's Ministry of Railways (MOR) and/or significant contract wins from the international markets.