800 Super Holdings Ltd - Steady pipeline of projects
- 2Q S$39.39mn revenue in line with our forecast of S$39.53mn.
- 2Q S$3.63mn net income missed our forecast of S$4.25mn by 15%.
- 1H S$78.84mn revenue met 48.7% of our full year forecast of S$162.0mn.
- 1H $8.145mn net income met 44.6% of our full year forecast of S$18.25mn.
- Introduced maiden interim dividend of 1.0 cent.
We are bullish on the stock because of the pipeline of projects.
- While the projects require capex, we view it positively that the company is reinvesting capital into new projects. We argue that investing in projects with a higher return than the cost of capital creates value for shareholders.
Margin expansion due to strict cost control; sustainable margins going forward
- Operating expenditure (OpEx) was 2.4% lower year on year (yoy), mainly due to lower staff costs (largest cost component) and lower purchases of supplies and disposal charges (second-largest cost component).
- We understand from management that the yoy lower staff costs was due to lower headcount, as the group improved on productivity through the use of machines and equipment; and the yoy lower purchases of supplies and disposal charges was due to start-up costs for a project in the previous year. In view of these, we are expecting sustainable EBIT-margin in the low-teens going forward.
Treatment and disposal of sludge contract not contributing yet; details in next quarter
- 800 Super made an announcement on 27 October 2016, in relation to the contract from the Public Utilities Board. While the announcement stated that the contract starts from 7 November 2016, we understand from management that the project has not contributed yet. We understand that construction of the facility will only commence in 2Q CY18.
- Details on capital expenditure (CapEx) and the project timeline to be announced in the next quarter. However, we do expect the company to be taking on more debt to fund the construction cost of the facility.
- We have yet to include the contribution from this project into our forecasts. Hence, this is a source of further upside to our valuation of the stock.
Introduced maiden interim dividend of 1.0 cent; kept our payout ratio forecast intact
- We believe this will be welcomed by investors and trading liquidity of the stock may improve going forward. In view of the interim dividend, there will be a one-off higher cash out flow in FY17. We continue to assume a full year dividend based on 30% payout ratio.
- However, our FY17F/FY18F dividend forecast of 2.75/3.00 cents is now lower than our previous forecast, as we have adjusted our FY17F/FY18F net profit forecast lower by 9.7%/10.5%, in view of our over-estimation for 2Q FY17.
Upgrade to "Buy" rating with higher target price of S$1.42 (previous: S$0.92)
- The significantly higher target price is due to change in valuation method from relative valuation to intrinsic discounted cash flow (DCF) and the rationale is explained overleaf.
- Our target price gives an FY17F forward P/E multiple of 15.4x, which is slightly higher than the Straits Times Index (STI) implied P/E multiple of 14.4x (Source: Bloomberg).
- 800 Super has consistently outperformed the benchmark index since we initiated coverage on the stock, and we believe that it will continue to do so, thus justifying the premium over the benchmark index.
- We have changed our valuation method from the previous relative valuation to intrinsic discounted cash flow (DCF) model.
Relative multiple valuation has become unsuitable
- When we initiated coverage on the stock in September 2014, we had used 8.0x P/E multiple to value it because of the major contracts that are of 6 or 7-year tenures. Our P/E multiple used to value the stock had changed a few times during the course of our coverage and in our last report, we had pegged 800 Super's valuation to 9.0x of its forward P/E.
- With the new projects coming on line, the revenue contribution from the major contracts will be diluted in significance. Hence, valuation should not be pegged to the tenures of those major contracts.
- Pegging the P/E multiple to the nearest peer has also become unsuitable, as the growth profile and especially capital structure of the two companies are clearly different.
Change in valuation model to FCFF
- We are using the free cash flow to firm (FCFF) model, primarily because of the uncertainty in debt level going forward.
- We are expecting the company to take on more debt for the material recovery facility (MRF) project and the sludge purification and disposal facility.