IJM Corporation - Diversifying into oil and gas

We attended IJM’s analyst briefing yesterday to get the update on its acquisition of the 25% stake in Scomi Group Berhad  (SGB). We are slightly negative on the acquisition due to the risks lingering in SGB as a whole, at least in the near term. Hence, we are maintaining our MARKET PERFORM recommendation with a lower Target Price of RM5.00 (previously at RM5.55) as we are now pegging a 10% discount to our SOP valuation due to the risk of its new business venture in oil and gas industry through the stake above. Despite SGB’s sizeable order book at RM2.9b, its engineering division could incur additional provisions due to the delay in its ongoing projects in India. To date, the engineering division’s outstanding contracts are worth up to 55% of SGB’s total order book. That said, one positive factor is that IJM will be able to leverage on SGB’s “Bumi” status to apply and bid for Petronas contracts. This is further strengthened by SGB’s existing capacity to execute such contracts. In the medium term, we reckon that the downside risk for the investment is capped at RM149m or c. 11sen per share (assuming SGB failed to record any  profits for the next three years). The key rerating catalyst for IJM now will be positive earnings contribution by SGB, which is likely from next year onwards, and additional construction project wins in the near term. 

Entry price is fair.  Based on SGB’s annualised earnings, the acquisition price appears to be fair at 11x PER (average cost of 33 sen per share) supported by SGB’s Petronas license. For the past two years, SGB has been recording losses due to hefty provisions and cost overruns from its  ongoing projects. IJM’s management believes that SGB is at the tip of a turnaround in the near term, probably after the completion of its (SGB) corporate restructuring by 1Q13. Based on the proposed restructuring plan, an SPV will be formed and will be listed on Bursa. SGB’s profitable subsidiaries like SMB and Scomi Oilfield Ltd (Eastern) (SOL) will be transferred to the SPV. SGB will effectively hold around a 65.6% share in the SPV after the restructuring exercise (including the offer for sale).          

Minimal contribution to IJM. SGB’s current order book stands at RM2.9b, which could last it for the next three years. Assuming a 10% net margin, the contribution to IJM is about 4% of our FY14E earnings. Nonetheless, the contribution could be further diluted with the potential provision from its engineering division due to the delay in its Mumbai monorail project. On top of that, management guided that SGB will make additional provisions by 1Q13 arising from the restructuring exercise i.e. on the put option exercise. 

Utilisation of the proceeds. SGB will utilise the proceeds for the repayment of its outstanding RM200m Medium Term Note (MTN), which is due by 28^th September 2012. However, the bondholders have granted an extension. SGB is expected to raise up to RM50m from the sale of its assets in Nigeria, which we believe will be used partly to finance the repayment of the MTN. 

MARKET PERFORM.  We are maintaining our  MARKET PERFORM recommendation with a lower Target Price of RM5.00 (previously at RM5.55) as we have assigned a 10% discount to our SOP valuation due to the risk of it diversifying into unfamiliar business venture and the high risk on SGB’s current projects, in particular, its monorail project in India. The composition of SGB’s order book is led by Scomi Engineering (55%), SOL (38%) and SMB (6%). That said, on the overall, we are retaining our forecasts on FY13-14E forecasts at the moment for IJM.   

Source: Kenanga