SAM Engineering - OUTPERFORM - 29 May 2012

We are initiating coverage on SAM Engineering & Equipment (“SAM”) with an OUTPERFORM rating and a Target Price of RM3.50 based on SOP valuation. The fair value is made up from three key components i.e. 1) its core business value at RM1.50/share, 2) the engine casing business at RM2.70/share and 3) the net debt of –RM0.70/share. The acquisition of the aerospace engine casing business from its parent company, SPE will allow SAM to balance its earnings volatility and move up further in the value chain via improved technology competencies. SAM’s key earnings catalysts are 1) sustainable revenue growth in the engine casing business underpinned by heavy back log of orders, 2) stable margins in the aforementioned business due to the absent of raw materials price risk; 3) steady pricing in HDD and semiconductor equipments and 4) strong parentage (Temasek) support. The group’s biggest risk is forex risk due to the nature of its core business. 

Balancing earnings volatility. The acquisition of the engine casing business from its major shareholder, Singapore Precision Engineering Ltd (SPE) will allow SAM (whose core business is now mainly involved in the semiconductor and HDD industries) to balance its earnings volatility. The technologies that will come through via this transaction will also serve as a platform to expand its businesses to the manufacturing of vacuum chambers for the semiconductor front-end, LED and solar industries. 

Immediate jump into a high-barrier business for entrants and also a move up the value chain. The engine casing business has a high barrier of entry for newcomers due to the high capex requirement involved in setting up the facilities and the need for the right expertise required to administer the technology. The proposed acquisition will allow the group to immediately capitalise on the established track record of the established business acquired and venture up the value chain of precision engineering via the aerospace business. On top of that, with the transfer of technology from the engine casing business, this will enable the group to tap into other industries where the components and assemblies used demand a high degree of quality and precision. 

Stable earnings for engine casing business will reduce the downside risks for the Semiconductor and HDD segments.  We expect a stable yet sustainable revenue growth (5.5%) for SAM’s engine casing business with its PBT and PAT margins likely to be maintained at 7% and 5.8% respectively from FY13 to FY14. Meanwhile, we also forecast a stable ASP for the equipments segment (Semiconductor and HDD) but note that there will be potential volatility in the production volume due to the cyclical nature of the semiconductor and HDD industries. 

Fair value of RM3.50,  based on Sum-of-Parts (SOP) valuation methodology. We expect the group’s FY14 aggregate PAT to achieve RM30.3m, which comprise of RM15.5m from its core business and RM14.8m from the full year earnings impact of the aerospace engine casing business. By applying an industry average of 8.3x to the group’s equipment division and a forward market PER of 15.0x to its aerospace engine casing business segment, we derive a fair value of RM3.50 for SAM, implying forward FY13 and FY14 PERs of 9.9x and 8.3x respectively. Given that the current share price provides a potential capital upside of 15.5%, we are assigning an OUTPERFORM rating on the stock.   

Source: Kenanga