Yongnam Holdings - CIMB Research 2017-10-26: Strutting Turnaround

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YONGNAM HOLDINGS LIMITED AXB.SI

Yongnam Holdings - Strutting Turnaround

• We initiate Yongnam with an Add and Target Price of S$0.53, based on 0.8x FY18 P/BV (10% discount to long-term average). Contract wins are the key catalysts for the stock.
• Using existing capacity, Yongnam aims to tender for S$1.16bn worth of projects for 2017-18 award. This includes c.S$500m of struts projects for North-South Corridor.
• As a steel provider for Singapore’s iconic projects, Yongnam sits on 208k tonnes of struts and steel plate assets worth S$242m (S$0.46/share) at end-FY16.
• Yongnam is trading at 5x FY19 P/E and 0.5x FY18 P/BV, below its long-term average of 6x forward P/E and 0.9x P/BV. Based on the projects in tender and a 50% hit rate, losses in FY17 could be reversed in FY18F to a net profit of S$10m. Earnings were c. SS$47m p.a in FY08-12.

Leading structural steelworks and struts provider 

Steeped in history 

• Yongnam was founded in 1971 as a small business providing mechanical engineering services, with an initial staff strength of five site workers. Over the years, the group has grown into a multi-disciplinary engineering and construction company involved in structural steelwork and specialist civil engineering.
• The company is also able to offer design and build services and mechanical engineering work. It was listed on the mainboard of FSSTI on 11 October 1999 at S$0.36 per share.

The go-to steel partner among main contractors 

• Yongnam has actively contributed to the construction of the Mass Rapid Transit system, expressways and a host of high-profile iconic projects in Singapore.
• Regionally, it has also performed work for the Brunei Royal Pavilion Hanger, Thailand’s Suvarnabhurmi International Airport and Hong Kong’s MTR extension, to name but a few.
• Yongnam usually allies itself with a main contractor to tender for jobs. Its clients include established names in the industry, such as Takenaka Corporation, Samsung Corp, Penta Ocean, SK Engineering, Obayashi Corporation and Sembcorp D&C.

About struts 

• Proprietary modular strutting systems. This consists of steel struts, which Yongnam leases out, to provide deep excavation support during the construction of stations and tunnels for transportation systems and building basement projects. This strutting system, which allows for a safer and more efficient construction of basement works, is the pride of Yongnam. Its modular strutting system that are bolted together minimises repeated cutting and welding that can lead to steel wastage. Struts are commonly used in Singapore mainly due to its soft ground conditions, requiring strong support during the tunneling work.
• Following the collapse of the Nicoll Highway in 2004, Yongnam’s strutting systems have emerged to become the preferred deep excavation support method used for underground construction work.
• Barriers of entry. With a traceability procedure that meets the requirements of the Singapore Building Construction Authority (BCA), Yongnam’s modular strutting system is the first to be certified by an independent auditor for reusability in earth retaining or stabilising structures. Yongnam’s struts are categorised into different specifications and can be reused to support at least two to three projects. This is a major barrier to entry as one needs to have sufficient projects on hand before investing in the struts. The tedious audit process by BCA could also serve as a hindrance for newcomers. Finally, we believe the initial margins for competitors may be lower given their higher cost bases today, even if they manage to secure decent market shares.
• In specialist civil engineering, competitors are private companies, Fuchi Pte Ltd, Hirose (Singapore) Pte Ltd and SGX-listed Kori Holdings Ltd (KHHL SP, Not Rated). There are no companies providing strutting services in Hong Kong.
• Sufficient inventory of 208k tonne of struts and steel plate. Yongnam owns the biggest strutting and steel plate asset base in Singapore. The strutting assets grew from 58k tonnes in 2007 to 208k tonnes currently, with peak capex spent in 2008-2012 (average capex of S$70m p.a), during the last construction boom. Management believes its capacity far exceeds the combined capacity of the next three largest players (Hirose, Fuchi and Kori). Generally, there has been a lack of contractors with sizeable strutting assets that could pose major threats to Yongnam’s dominance. No significant capex is needed for now. Asset replacement or maintenance capex is S$20m-25m p.a (6-8% of total struts assets). Although struts have useful lives spanning 30 years, Yongnam depreciates them over 15 years.
• Struts are valued at c.S$242m or S$0.46/share. The book value of the 208k tonnes of struts is worth S$242m or about S$1,160/tonne. Given a lack of strutting capacity in the industry, competitors seeking a slice of the pie would have to invest in new struts that would not come cheap. According to management, brand-new steel struts cost S$1,600/tonne to buy and fabricate. This provides an instant edge for Yongnam over newcomers. It effectively improves its competitiveness in contract tendering by giving the company more flexibility in contract pricing. Scrap value for the struts would fetch c.S$400/tonne.
• Competition. In struts, competitors are private companies, Fuchi Pte Ltd, Hirose (Singapore) Pte Ltd and SGX-listed Kori Holdings Ltd (KHHL SP, Not Rated).

About structural steel 

• Accredited structural steelworks. Structural steel forges the skeletons of buildings, infrastructure and temporary support for deep excavations. Structural steel work consists of the fabrication of structural steel (cutting and welding) and its installation.
• The advantages of using steel over conventional materials such as concrete for building construction include
  1. the speed of construction,
  2. superior material strength to volume ratio, and
  3. flexibility in design and aesthetics. 
• With more than 40 years of experience in steel fabrication, Yongnam has a combined structural steel fabrication capacity of 84k tonnes in Singapore and Nusajaya, Johor, Malaysia. This, is more than double of its 36k tonnes capacity in 2007. For now, there are no plans to expand the capacity.
• Yongnam is an ISO 9001:2008, ISO 14001:2004 and OSHAS 18001:2007 certified company and accredited fabricator of the highest S1 category from the Singapore Structural Steel Society and holds A1 Grades from the Singapore Building and Construction Authority for the categories of General Building and Civil Engineering.
• Competition. For structural steelworks, competitors include SGX-listed TTJ Holdings Ltd (TTJ SP, Not Rated) and Bursa-listed Eversendai Corporation Bhd (EVSD MK, Not Rated) and unlisted JFE Engineering.

Visible near-term projects in Singapore 

Strong line-up of potential contracts 

• Contract wins are the key catalysts for the stock. Yongnam is tendering for at least S$1.16bn worth of projects in Singapore and overseas, to be awarded from now till 2018. This, would provide enough work for the next three years. 
• The biggest component of projects under tender comes from the North-South Corridor. 

S$15bn North-South Corridor project 

• One of six bidders in package N106 for North-South Corridor. Yongnam has partnered with SK Engineering & Constructions in a 40/60 JV to submit a bid of c.S$952m-965m for the design and construction of North-South Corridor (tunnel) between Novena Rise and Toa Payoh Rise. Other contenders include Hyundai E&C (S$1.1bn), Lum Chang Building Contractors (S$1.5bn), Samsung C&T Corp (c.S$809m-849m), Sinohydro Crop (S$1.03bn) and Ssangyong E&C/Wai Fong Construction (S$1.07bn). We expect to hear of the final award before end- 17 from the Singapore Land Transport Authority.
• If Yongnam / SK E&C JV does not win the main-con job, Yongnam still has the flexibility to be the sub-contractor of the winning main-contractor for the strutting works. In our forecasts, we have only factored in struts sub-contracting work.

Winning the main-contractor’s job is a bonus.

• 11 packages in North-South Corridor worth S$15bn, struts worth S$500m. North-South Corridor is split into 11 packages of civil engineering work worth up to S$15bn, including the main contractors’ work. The struts portion is worth c. S$500m, of which we believe Yongnam could clinch at least 50% of it (S$250m) given its large asset base.
• The average hit-rates in Singapore expressway projects have been 80% and 30% for train lines. The last major award of express way was the MCE in 2009- 2010 totaling S$364m.

Lost bids are never lost 

• Yongnam and Daewoo Engineering & Construction lost the tender (submitted S$1.18bn) for Kim Chuan Depot Extension, Circle Line 6. The winning contractor, Woh Hup (Private) submitted a bid of S$1.21bn. 
• We think Yongnam is positioned to strike a subcontracting job with Woh Hup, as the latter is one of its long-term contractors.

Overseas projects from Melbourne and Hong Kong 

Track record holds the key to project wins. 

• Yongnam’s participation in overseas projects usually stems from invitations from its existing clients to support their project bids overseas. 
• As a testament to its technical expertise and reputation, more local contractors have been approaching Yongnam for partnership opportunities. In some of these cases, Yongnam adds value by filling in the technical expertise that the local contractors lack, without which the local contractors would not be able to bid for certain projects.

Melbourne Metro. 

• A consortium comprising Lendlease Engineering, Capella Capital, John Holland and Bouygues Construction have been selected to deliver the Metro Tunnel and five new underground stations in Victoria, Australia.
• According to management, Yongnam’s struts systems designs were used to bid for the project. Therefore, we expect to hear of subcontracting contract award by the consortium soon.

West Gate Tunnel, Victoria. 

• John Holland/ CPB Contractors JV is also the preferred contractor to deliver Victoria’s West Gate tunnel project, to widen the freeway from eight lanes to 12 with the complementary bridge/road works. We believe Yongnam is also in the running for the struts work.

More from Hong Kong’s Kai Tak Development. 

• We expect to hear of more packages coming out of the Hong Kong Kai Tak development (Central Kowloon route). 
• Yongnam was awarded by China Road and Bridge Corporation in 2016 for the underground work for the east-west express link between West Kowloon and Tseung Kwan O.

Tuen Mun – Chek Lap Kok Link. 

• Yongnam is also in the running for struts work for the Tuen Mun to Chek Lap Kok tunnel work that was awarded to its long-term main-contractor, Dragages Hong Kong. The 4.6km tunnel running 60m below sea level is part of a strategic new route linking Hong Kong’s airport on Lantau Island and the New Territories.

Financials 

Segmental information 

• Singapore accounted for 90% of the Group’s revenue while Hong Kong accounted for the remaining 10%. 
• In 2Q17, structural steelworks (62% of revenue) and specialist civil engineering- struts (30% of revenue) were the main revenue contributors by business segment. Going forward, we expect to see the split to become 50/50 based on the projects under tender.

Order book to hit a record again in 2018 

• YTD, it won about S$106m of projects with an order book of S$205m (excluding S$54m JTC Logistics Hub project won in Aug 17). About 45% of the orderbook will be consumed by 2H117, and the remaining in FY18. 
• Based on the projects under tender, mainly NSC, we estimate Yongnam to clinch S$535m worth of orders in 2018 and S$435m in 2019. We estimate an order book of S$503m by the end of FY18, a new record.

Forget about FY17; profits should return in FY18F and double in FY19F 

• Yongnam has been posting multi-year losses since FY14. We forecast the trend to continue for FY17, with a net loss of S$14m based on the completion of current projects. 
• Yongnam has been plagued by the sluggish construction sector over the past 4 years, especially after the completion of major infrastructure projects, such as Marina MBS Integrated Resort, MCE and expansion of the MRT network. Utilisation of struts plunged to a low of 25% in FY17 and 30% currently, from the peak of more than 70%. This resulted in poor operating leverage of overheads. 
• Management guided that optimal utilisation should reach 60% for costs to be fully allocated.
• Based on the progressive award and revenue recognition of potential projects (18-36 months from award), we forecast utilisation to improve to c.50% before hitting a full 60+% in FY19F. Therefore, an earnings turnaround is likely to kick in from 3Q18F. 
• We forecast a net profit of S$10m in FY18F, more than doubling to S$27m in FY19F. At its peak (FY08-12), net profit was c.SS$47m p.a.

Margin assumptions 

• During the boom years, gross margins for structural steelwork typically averaged 20% while margins for strutting projects averaged 30%. Given the rising cost of operations and the highly competitive landscape, gross margins have narrowed in recent years. Structural steel now fetches about 15% while struts about 20%. 
• Our blended GMs are conservatively set at 13% and 18% for FY18 and FY19, respectively. Upside could come from stronger margins for overseas projects (less competition).

Net gearing and financing 

• Its net gearing stood at 0.3x as at 1H17 with a total debt of S$100.4m (S$84.5m current, S$15.9m non-current). It completed the placement of 47.5m new shares at S$0.255 apiece on 17 Oct 17 to raise net proceeds of S$11.85m. This will be used for working capital and we believe to bid for projects underway. 
• We believe refinancing plans could be on the cards.

Valuations & Recommendation 

Below historical average 

• Yongnam appears inexpensive, trading at 5x FY19 P/E. Excluding boom and bust cycles in 2007-2009, Yongnam’s 12-mth forward P/E traded between 7-9x in 2005-2011. 
• On a P/BV basis, we believe the under-utilised struts have caused the widening of book values and market values to 0.5x FY18 P/BV currently. Its long-term average since 2009 has been about 0.9x P/BV.

Initiate with an Add and target price of S$0.53 on 0.8x P/BV 

• We conservatively apply a 10% discount to the long-term average of 0.9x P/BV to factor in a certain degree of uncertainty in project awards. Our TP implies a forward P/E of 9x, within its own trading band during the profitable years.
• Key catalysts to the stock are new contract wins and evidence of its successful execution of projects.

Key Risks 

Project delays. 

• As multiple stakeholders are usually involved in any given project, the risk of any one running behind schedule can lead to project delays.
• Furthermore, the government could come in to dictate a deferral, especially with regards to public work projects. This was the case with the North-South Corridor which was supposed to start work in 2017 but is now delayed to 2018.
• Yongnam’s strutting system is usually employed during the early stages of projects.

Cost overruns. 

• Any regulatory embargo could lead to a surge in material prices.
• Labour shortage could also lead to cost overruns. Yongnam currently has 1,450 staff, including 950 workers. Any award of major projects could entitle Yongnam to up its workers quota on project basis. 

Lumpiness in earnings to be expected. 

• As an order book-driven business, the timing of contract wins is uncertain. Consequently, revenue recognition may be lumpy quarter to quarter.

LIM Siew Khee CIMB Research | http://research.itradecimb.com/ 2017-10-26

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