CSE Global - UOB Kay Hian 2018-05-02: Safe Proxy To The Oil Recovery With 6.6% Dividend Yield

CSE Global - UOB Kay Hian 2018-05-02: Safe Proxy To The Oil Recovery With 6.6% Dividend Yield CSE GLOBAL LTD SGX: 544

CSE Global - Safe Proxy To The Oil Recovery With 6.6% Dividend Yield

  • With the ability to show profits despite the oil price storm of 2015-17, CSE is now an excellent yet safe proxy to the current oil price recovery.
  • While it reaps the profits on its successful diversification into the high-margin infrastructure space, the US tax cuts should also bring greater profitability.
  • A net cash position, strong cash flows and order wins should sustain an attractive dividend yield of 6.6%.
  • Initiate with BUY and target price of S$0.58, based on 15x peers’ average PE.



WHAT’S NEW


We initiate coverage on CSE Global (CSE).

  • Initiate coverage with a BUY and PE-based target price of S$0.58. The stock offers a very attractive yet sustainable dividend yield of 6.6% supported by CSE Global’s (CSE) strong cash flow and willingness to reward minority shareholders.
  • 32-year year track record in a business with high entry barriers. Founded in 1985, CSE is one of the few qualified system integrators in the region for the oil and gas (O&G) and communications infrastructure industries. Due to the nature of its work which makes it difficult for new entrants to enter, CSE has close working relationships with blue-chip customers such as Shell, Exxon Mobil and enjoys superior pricing dynamics.
  • Excellent proxy to the oil price recovery that provides safety with considerable earnings upside. While CSE experienced challenging years in 2015-17 given the slowdown in the offshore O&G business, they were still able to continue their track-record of profitability by diversifying into the high-margin infrastructure space and the onshore O&G business. With oil prices stabilising and offshore O&G looking profitable, we believe that CSE is well-positioned and will be able to pounce on opportunities in the recovering sector and add to its bottom line.
  • Expenses controlled with US tax cuts and completed “kitchen sinking”. Given that CSE holds significant US exposure, we believe that CSE will be a beneficiary of the US tax cut which sliced the corporate tax rate from 35% to 21%. Tax savings for CSE could amount to almost S$1m p.a. Also, in 4Q17, CSE conducted an aggressive “kitchen sinking” exercise and minimal impairments should be expected going forward.
  • Reaping the profits of a successful diversification. In 2015 and 2016, in light of the oil crash, CSE embarked on a series of acquisitions in Australia in an effort to become a nationwide player in the 2-way radio communication infrastructure business. Today, CSE is reaping the profits of this successful diversification into the high-margin 2-way radio communications business.
  • 6.6% dividend yield given net cash position, strong cash flow and sustained order wins. For the past four years (2014-17) despite the downturn in the O&G sector, CSE has continually rewarded shareholders with a 2.75 S cents/share dividend. With its solid net cash position, we expect 2018 and 2019 to be no different and yield 6.6% dividends backed by the recovery in earnings and strong cash flow.
  • New substantial shareholder is a synergistic fit for CSE. On 13 Apr 18, Malaysian- listed Serba Dinamik bought a 24.8% stake in CSE from 8 substantial CSE shareholders at a price of S$0.45/share. We view the acquisition as a positive development for CSE as it could likely open up new markets for CSE with the potential for JVs between the two entities. M&As remain a distinct possibility as CSE trades at undemanding valuations with strong cash flow.


VALUATION / RECOMMENDATION

  • Initiate coverage with a BUY and PE-based target price of S$0.58, pegged to peers average 2019F P/E ratio of 15.0x. Given Serba’s entry price of S$0.45/share, we believe that the stock is undervalued given our expectations of a 20% 3-year EPS CAGR from 2017-20 and PEG of only 0.5x vs peers of 1.6x.
  • Going forward, we see potential for upside especially in 2019 as the impact of the synergies between Serba and CSE start to flow in which could come in the form of JVs or possible outsourcing of work from Serba. The stock offers an above-average sustainable yield of 6.6% backed by strong operating cash flow and the willingness to reward minority shareholders.


SHARE PRICE CATALYST

  • Recovery in oil prices.
  • Large O&G project wins.


32-Year Track Record With Strong Engineering Capabilities


Long track record in industrial systems integration.

  • CSE is a global industrial systems integrator serving the:
    1. O&G industry,
    2. infrastructure industry, and
    3. mining industry.
  • The group’s core capabilities lie in designing and implementing command and control systems for large scale projects such as Singapore’s ERP gantries and large scale plants and processes for oil majors such as Shell and Exxon Mobil by offering cost effective, totally integrated solutions to these industries.

CSE was founded in 1985 as part of the engineering projects division of Chartered Electronics Industries,

  • ... the electronics arm of Singapore Technologies. In 1997, CSE underwent a management buyout when key personnel were offered the opportunity to own a significant part of the company. The company’s current Chairman of the Board, Mr Lim Ming Seong, was part of the management team that partook in the corporate exercise.

The key difference between CSE and other system integrators

  • ... in the region is the use of an inventory-light model whereby CSE sources third-party technology for system integration projects. Competitors such as Japanese-listed Yokogawa Electric Corporation have manufacturing facilities to produce in-house products such as pressure valves.

Still perceived as a pure-play O&G company.

  • Today, CSE operates across a broad range of industries around the world which is vastly different from how the company was 10 years ago where the majority of sales came from the previously lucrative offshore O&G segment. 
  • CSE is now a more diversified entity serving the onshore shale market, transport, power utilities, waste water utilities and mining industries. Even as the group has diversified away from deep water offshore O&G revenues due to the sector downturn, the group has retained its competencies in this space as any extended rebound in oil prices would galvanise capex spending in the deep water segment.


Business Model With High Barriers To Entry And Customer Stickiness


High barriers to entry.

  • CSE is one of the few system integrators in the region that is qualified to perform system integration work for O&G majors and infrastructure players. 
  • Naturally, the entry barriers to large scale system integration works are high as any loss of data or subpar monitoring of facilities could result in loss of lives or heavy financial losses. This technical engineering know-how and long track record has acted as an entry barrier, allowing CSE better pricing power.

Customer stickiness due to maintenance work involved.

  • When CSE wins any systems integration projects, they are almost guaranteed to benefit from subsequent upgrading and maintenance works as the design framework and model is owned by CSE. For instance, CSE currently maintains and operates the critical 2-way radio system for certain key airport and the coast guard installations in Australia which have been the main driving force behind the growth in infrastructure sales over the last few years. 
  • In 2017, we estimate that approximately 63% of total revenue in 2017 was related to system upgrading projects and recurring maintenance works.

Technical know-how.

  • Approximately 90% of CSE’s workforce of 1,100 employees is made up of engineers or technicians involved in implementing control systems that play critical roles in systems monitoring by providing real time data to a command centre to minimise potential disruptions. 
  • For the O&G industry these include process control systems, safety shutdown systems, and fire and gas detection systems. For the infrastructure segment, these include VSAT satellite communications networks, construction communications and fibre optic systems. 
  • The strong technical knowhow has allowed CSE to enjoy healthy margins while entrants with little to no track record will find it difficult to penetrate this space.

Rebound in oil prices will likely see extraordinary profit returns.

  • Capex spending in the deep sea offshore oil business is highly dependent on oil prices. We expect that deep sea offshore oil spending from the oil majors is likely to return should oil prices sustain above the US$75 level. At that level, there would likely be large-scale Greenfield projects up for tender which would see better margins and stronger orderbook wins for CSE. 
  • Generally, when CSE wins a Greenfield project from a customer, securing subsequent Brownfield from customers is virtually guaranteed.


Earnings And Financials


Orderbook driven business.

  • CSE’s outstanding orderbook has declined steadily from 2014-16 but recovered slightly in 2017 due to more orders from the onshore shale oil and gas space. 
  • We expect the orderbook to continue growing from 2017-20, driven by a return to capex spending from oil majors and shale players together with sustained growth in the infrastructure segment. We estimate that the orderbook is consumed within 1-2 years.

Revenue and gross margins to expand further.

  • With the recovery in the orderbook, we expect revenue and gross margins to follow suit. Further growth in the 2-way communications business and higher margin brownfield and maintenance projects should be supportive of a steady recovery in gross margins.


Risks


Weak oil prices.

  • CSE operates in the O&G space and is reliant on oil majors’ capex spending. If oil prices remain persistently weak, oil major spending will drop which will lead to smaller projects up for tender for the group.

Foreign currency.

  • CSE has transactional currency exposure arising from sales or purchases that are denominated in foreign currency. The group primarily deals in the Singapore dollar, US dollar, British Pound, Euro and Australian Dollar. The group also has trade receivables and payables that are denominated in foreign currency.

Credit risk.

  • CSE has exposure to credit risk that may arise on the outstanding financial instruments should a counter-party default on its obligations. The group’s exposure to credit risk arises primarily from trade receivables. The group tries to minimise credit risk by dealing exclusively with high credit rating counter-parties.





Nicholas Leow UOB Kay Hian | Andrew Chow CFA UOB Kay Hian | https://research.uobkayhian.com/ 2018-05-02
SGX Stock Analyst Report BUY Initiate BUY 0.58 Same 0.58



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