PEC Ltd: 1QFY12 PATMI fell 71% on lower gross margins (OCBC)

1QFY12 results disappoint. PEC Ltd (PEC) reported a disappointing set of 1QFY12 results. Revenue increased by 2% YoY to S$110m but gross profit and profit after minority interest (PATMI) fell by 28% and 71% YoY to S$20m and S$2.5m respectively. The sharp fall in gross margin to 18% from 25% from the year-ago period was mainly due to stiffer competition. Operating expenses remained flat at S$15.6m (1Q11: S$15.4m), while finance expenses increased to S$0.4m (1Q11: negligible) due to issuance of bank guarantees and performance bonds. On a positive note, PEC's balance sheet remained strong with S$156m in net cash and its orderbook increased to S$340m as of end-Sep (end-June: S$300m).

Stiff competition and uncertain outlook. PEC's operating environment remains challenging over the medium-term horizon as it faces rising costs and stiff pricing competition. As mentioned in our earlier reports, the global uncertainty arising from the slowdown in US economy and European sovereign debt issue would have an adverse impact on the downstream oil and gas sector. As oil and petrochemical companies push back their large infrastructure investments, local EPC companies (e.g. PEC) will have to contend with fewer project tenders and/or lower margins. Although PEC's order-book increased to S$340m at of end-Sep, we suspect the newer contracts wins may come with lower gross margins of about 20% (compared to an average 26% over FY06-FY11).

S$156m net cash. As of end-Sep, the group's balance sheet remained robust with S$156m in net cash. This should enable PEC to seek inorganic growth opportunities, i.e. through acquisitions or joint-ventures, as and when they arise. Separately, the group has also announced that it has fully utilized its IPO cash proceeds (including over-allotment option) of about S$26.2m.

Maintain BUY with lower fair value estimate of S$0.92. We are keeping our FY12 revenue estimates largely unchanged but reduced our blended gross margin assumption to 19% (previous estimate: 25%). As a result, our FY12 PATMI estimates fell by about 50% (Note that PEC's net profit is highly sensitive to gross-margin changes). We continue to value PEC's share using SOTP valuation method - including valuing its operations at 5x FY12F earnings and net cash of S$0.61 per share - to obtain a revised fair value estimate of S$0.92 (previously S$1.32). Maintain BUY. Potential catalyst may come from earnings accretive acquisitions and downside risk is limited due to the strong net cash position.