Pantech ... Jan12

Insider Asia Research

- Sales in 3QFYFeb12 up 49% y-y and 12% q-q
- Trading sales registered good traction
- Expect strong double-digit growth in FY12-FY15
- 2012E annualised P/E of only 5.1x with 6.5% net yield

Pantech Group Holdings’ earnings results for 3QFYFeb2012 were broadly in line with our expectations.
Total sales were up 49.4% y-y and 12% q-q to RM112.7 million, underpinned by improving demand in both the domestic and export markets. Trading sales, which accounted for some 64% of the company’s total sales in the quarter, expanded to RM72.1 million, up from RM60 million in 2QFY12.

We estimate roughly 80-85% of trading sales are for domestic consumption. Local demand is expected to improve further in 2012 as more oil & gas projects under the various government initiatives, including the Economic Transformation Programme, are rolled out.

The national oil company, Petroliam Nasional intends to spend some RM250 billion over the next five years, to develop new projects, including marginal oil fields, as well as undertake enhanced oil recovery from existing oil fields. Thus we expect robust demand for downstream support services and equipment such as the pipes, fittings and flow control products sold by

Pantech going forward.
Meanwhile, export sales too did quite well, holding at some RM40.6 million in 3QFY12 on the back of fairly resilient export demand – despite the increased global economic uncertainties, triggered by the deteriorating debt crisis in Europe during the period.

The carbon steel manufacturing facility in Klang is running at full capacity while Pantech’s current six production lines at the new stainless steel plant is also nearing full utilisation. However, the latter remains in the red in the latest quarter. We had expected the new lines to be breaking even by end- 3QFY12.

This slight delay in turning a profit was due to falling raw material prices globally, including that for nickel. Nickle is a key component in influencing prices for stainless steel products. Heightened concerns over the euro zone crisis and health of the global economy sent commodity prices tumbling in 2H11 as investors shun risky assets. The average price for nickel in November 2011 was almost 25% lower than that in July 2011. As a result, Pantech’s margins were squeezed by higher stock cost in an environment of weakening selling prices. Positively, improvement in the trading arm and resilient earnings from carbon steel manufacturing more than offset losses at the stainless steel plant. Net profit in 3QFY12 rose to RM10.3 million, up 67% y-y and 43% from the immediate preceding quarter.

The company announced a second interim dividend of 1.2 sen per share. The stock will trade ex-entitlement on February 27.

Earnings Outlook
Pantech’s earnings have been improving in the last three consecutive quarters. Net profit improved from RM5.1 million in 4QFY11 to RM6.2 million and RM7.2 million in 1QFY12 and 2QFY12, respectively. Net profit expanded further to RM10.3 million in the latest 3QFY12.

We expect this trend to persist through 2012 on the back of upbeat forecast for the oil & gas sector going forward. To be sure, there are some concerns that global economic growth could stall especially if the debt crisis in the euro zone worsens further. Nevertheless, recent economic data out of the US shows that the world’s largest economy is in a better shape than previously expected.

With the US job market on the mend, rising consumer confidence will underpin consumption, which accounts for 70% of the country’s economic activities. Meanwhile, many expect China to gradually loosen monetary
policy to spur domestic consumption and counter slower external demand. At the moment, most expect the government to succeed in engineering a soft landing for the world’s second largest economy.

Thus, the global economy is still expected to register positive growth, albeit at a more modest pace.
Prices for crude oil have held up well through the recent volatility in financial markets. Crude oil futures on the New York Mercantile Exchange are currently hovering around US$100 per barrel, a level that is supportive of exploration and production activities in the oil & gas sector. Thus, we expect demand for Pantech’s pipes, fittings and flow control products to gain traction, both in the domestic and export markets.

The company’s order book for its carbon steel products runs up to June 2012 while that for stainless steel products is full till April 2012. Orders for the latter is shorter-term at the moment due to the more volatile price fluctuations. Positively, prices for nickel appear to have bottomed out in November 2011 and have since recovered by nearly 10%. A more stable price for the raw material this year would bode well for Pantech’s margins. The recent strengthening of the US dollar against the ringgit would also translate into
higher export sales for the company. Hence, we do expect the first six stainless steel production lines to start turning a profit soon.

Pantech is slated to complete its near-term capacity expansions over the next one-two months. The additional machineries to manufacture, primarily, high frequency induction long bends, at the Klang facility are in place and will commission by end-FY12.

Meanwhile, three of the four additional production lines in the new stainless steel plant are nearing completion. The final line is expected to be up and running by April 2012.

The four new lines will expand its current production range to include biggersized pipes and also fittings. Production at this plant is estimated to rise to 12,000 metric tonnes per annum in FY13, from the current 7,000 metric tonnes.

Elsewhere, Pantech is actively exploring various options to further expand its product range to encompass higher value and margin alloy products such as copper-nickel, duplex and super duplex pipes and fittings that are corrosion resistant. This may include acquisitions and/or expansion at its local manufacturing plant.

Valuation and Recommendation
Pantech’s well-laid out strategy should enable it to achieve strong doubledigit annual growth over the next few years – based on the expected strengthening in demand that is supported by the company’s expansion plans.

We are fine-tuning our FY12 earnings to take into account the slight delay in breakeven for the stainless steel plant. Net profit is estimated at RM36.2 million – up 25% from the RM29 million in FY11. On the other hand, we are revising slightly higher our earnings forecast for FY13, to RM49.9 million. Based on our forecast, the stock is trading at very modest P/E valuations of only 6.6 and 4.8 times, respectively, for the two financial years – or about 5.1 times our annualised earnings for 2012. Plus, the stock is trading below its net asset of 74 sen per share as at end- Nov 2011.

Pantech’s valuations compare very favourably against most oil & gas stocks listed on the local bourse, as well as the broader market’s average valuations.

Thus, we believe there is significant upside potential for Pantech, particularly for those with a slightly longer investment horizon. We maintain our BUY recommendation on the stock.

Investors can also expect attractive yields
On top of potential capital gains, shareholders can also look forward to attractive yields.
Dividends totaled 3.3 sen per share in FY11. For FY12, Pantech has paid interim dividend of 1 sen per share and has announced a second interim dividend of 1.2 sen per share.

For the full-year, we estimate dividends to total 3.5 sen per share, higher in line with the stronger earnings. This will earn shareholders an attractive net yield of 6.5% at the current share price. Going forward, we estimate dividends to increase further to 4 sen per share in FY13, giving a yield of 7.5%.