BRC Asia - Phillip Securities 2021-02-22: Light At The End Of The Tunnel; Initiate Coverage With BUY

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BRC ASIA LIMITED (SGX:BEC)

BRC Asia - Light At The End Of The Tunnel; Initiate Coverage With BUY

• Record earnings of S$42mn and S$45mn expected for BRC Asia in FY21e and FY22e respectively.
• Construction demand is expected to recover to S$23bn – S$28bn in 2021, recovering from the S$21.3bn in 2020. Their huge market share of 70% means BRC Asia is well positioned to capitalise on the growth.
• Potential for dividend payout to recover from FY21e and FY22e.
• Initiate coverage on BRC Asia with BUY recommendation and target price of S$1.87.

BRC Asia - COMPANY BACKGROUND

• BRC Asia (SGX:BEC) is an established pioneer in prefabricated steel reinforcement. Since their incorporation in 1938, they have developed their expertise to become a leading steel reinforcement solutions provider in Singapore. Today, they have operations in Singapore, Malaysia and China.
• Post the acquisition of Lee Metal in June 2018, BRC Asia is now the largest steel reinforcement supplier in Singapore with an estimated 70% market share.
• BRC Asia have operations spanning Singapore (84.5% of FY20 revenue), Malaysia and China and a total workforce of more than 1,000. BRC Asia has an annual processing capacity of 1.2 million metric tonnes.
• By transferring labourious and unproductive in-situ steel fixing work to factory fabrication, substantial benefits in on-site manpower savings, shorter construction cycle, better buildability and productivity can be achieved for the builder, leading to a better outcome for all stakeholders.

BRC Asia's Business segments

• BRC Asia is a market leader in providing pre-fabricated steel reinforcement solutions. They have the following main competitive advantages:
  1. Just-in-time delivery,
  2. 24-hour express cut-and-bend services, and a
  3. full-suite of prefab reinforcing solutions.
• BRC Asia offers a full suite of reinforcing steel products and services that include standard length rebar, cut and bend services, prefabrication services as well as standard and customised welded wire mesh for the building and construction industry.

Future plans

• BRC Asia has plans to continue its expansion into overseas markets such as China, Australia, Indonesia and Vietnam. They plan to pursue their expansion in the second half of 2021 or early 2022.
• BRC Asia has had a presence in China for about 17 years through a joint venture that supplies mesh products to high speed rail projects. But it has struggled to make significant inroads because it’s mainly dominated by state-owned enterprises. We think this may change however, because of their parent company Esteel Enterprise, which in September 2017 made an offer for the Group at S$0.925 per share.
• Esteel Enterprise, which currently has a stake of 71.9% in BRC Asia, is 80.1% controlled by You Zhenhua. You Zhenhua is the chairman and executive director of iron ore trader Prosperity Steel United Singapore, which has a significant presence in China’s steel industry.

BRC Asia - REVENUE

• BRC Asia supplies steel products to its customers. The steel products supplied by the Group are "Mesh" and "Cut and bend". A breakdown of the revenue mix is not available, though we believe a greater proportion of this is from "Mesh". BRC Asia continues to derive the bulk of their revenue from Singapore (84.5% in FY20) where it holds a dominant market position.
• As at end-Dec 2020, BRC Asia's order book stood at approximately S$1.09bn, with a duration of up to 5 years. This however, could be subject to further changes, as uncertainties loom over the construction sector. Nonetheless, it should be stated that while the order book gives a snapshot of the Group’s projects, the projects in their order book are received and completed on a rolling basis, and may not be representative of their overall jobs for the year.
• For FY21e, we expect BRC Asia to report revenue of S$832.5mn (+35.9% y-y) recovering from the drop in FY20 as activities in the construction sector resume.

BRC Asia - EXPENSES

• Steel rebars is the biggest cost component of BRC Asia, accounting for an average 91% of total revenue in the last three years. Despite its heavyweight on the P&L statement of the company, we think concerns over volatility of steel price on profitability is overblown. While steel price volatility will have an impact on BRC Asia’s short-term profitability due to accounting provisions, in the long-term, these provisions are reversed out as the Group meet their contractual obligations.
• The current accounting provision of onerous contracts require management to assess and estimate the costs to meet the obligations of certain sales contracts based on the value of inventory on hand plus estimated costs of inventory purchases and conversion costs incurred. An accounting provision of onerous contracts is made when the estimated costs to meet the obligations of certain sales contracts exceed the value of inventory on hand plus estimated costs of inventory purchases and conversion costs incurred. All things equal however, the relevant provisions for onerous contracts are reversed and credited back to the profit and loss statement when deliveries under such sales contracts are fulfilled.
• In other words, accounting provision for onerous contracts only reflect a snapshot of the business at a point in time, and not the actual impact of the business when they fulfil a contract. Over time as BRC Asia fulfill their contractual obligations, such provisions will be negated. This is because the Company ensures that in every sales contract they enter into, they are able to hedge prices (with forward contracts) and be profitable on them as they meet the obligations of the contract.
• BRC Asia generally hedge their requirements for inventory out for the next six to nine months, which means they do not bear any price risks during this period. Should the price of steel move up sharply during this period, this will be reflected in the average contract price of their new contracts. The main risk they face is for longer tenured projects since a complete hedging of the total inventory requirements is not possible. That said, given that the bulk of (we estimate this to be about two-thirds of their total order book) their order book will be fulfilled within 18-24 months, this in our view, mitigates the price risk of their contracts.

BRC Asia - OTHER INCOME

• BRC Asia recorded S$5.3mn in government grants for FY20 relating mainly to COVID-19 relief measures and support. The COVID-19 relief measures and support comprise mainly of Jobs Support Scheme grants, Foreign Worker Levy and Property tax rebates introduced in the 2020 Budget. A detailed breakdown of the different support measures are provided for in the Appendix section of report attached below.
• For FY21e, we have penciled in S$2.6mn in government grants to be recognised by BRC Asia as the grants taper off post-circuit breaker.
• We also recognised an S$1mn gain in FY21e from the sale of a property under LMG, a wholly-owned subsidiary of the Company held through Lee Metal Group Pte. Ltd. The property, located at 32G Nassim Road, Singapore 258414, has a land size of approximately 1,235 square metres. It is currently under development for a 2-storey detached house. The property is expected to be sold for an aggregate consideration of S$38.4mn this financial year with BRC Asia set to recognise an S$1mn gain from the sale.

BRC Asia - BALANCE SHEET

• BRC Asia's net debt was S$186.5mn in 1QFY21, or a net gearing of about 49% vs 76% in the previous quarter as the Group reduced their working capital requirements to reduce short-term debt due to the current COVID-19 crisis. For 1QFY21, BRC Asia has short-term debt of about S$60.4mn, which are mainly trust receipts issued for inventory procurement to meet orders on hand, and a floating charge on trade receivables for orders fulfilled.
• As the construction sector resumes work post circuit breaker, we expect the short-term debt to increase as BRC Asia ramps up capacity to meet new orders. We expect BRC Asia’s net gearing to stabilise at 67% and 76% for FY21e and FY22e as they gear up on working capital requirements to meet rising orders from the construction sector.
• We imputed a 3% default rate on BRC Asia’s accounts receivables for FY21e and FY22e in consideration of the stress faced by construction firms in this environment. We arrived at the 3% default rate by computing the average historical default rates in the construction sector and impute this for our forecasts. We have baked in impairment loss on trade receivables of S$5.3mn and S$5.5mn for FY21e and FY22e respectively.
• In our view, the allowance provided for BRC Asia’s accounts receivables represent a fairly aggressive allowance of their current accounts receivables since about 80-90% of their accounts are insured. Their market-leading position in the market (about 60-70% market share) also means that they are able to work with customers with a better credit profile, mitigating default risks.
• Barring another outbreak, we think BRC Asia remains well positioned to manage its accounts receivables exposure for FY21e and FY22e. Their recent placement of 10 million shares to a group of investors at S$1.42 a share saw the Group net S$13.7mn from the exercise, which should put it in good stead to ride out the crisis.

BRC Asia - CASH FLOW

• We expect BRC Asia to see a negative cash outflow from operations of S$25.9mn and S$19.6mn for FY21e and FY22e as working capital requirements increase for FY21e and FY22e. We believe this is manageable for the Group as they have previously tightened liquidity requirements for FY20e in response to the shut-down in the construction sector, generating S$122mn in surplus cash from this.
• We also expect BRC Asia to see a cash infusion of S$37.8mn from the disposal of the property from LMG.

BRC Asia - DIVIDEND

• In 2019, BRC Asia announced a dividend policy of paying out 30% of net profit attributable to shareholders for FY2019 and FY2020. We note however, that BRC Asia has paid out an average of about 60% of earnings since FY2019 with the Group declaring a special dividend in both years.
• We expect the formal dividend payout ratio to be unchanged for FY21e and FY22e. We note that BRC Asia continued to pay out a special dividend for FY20 despite the challenging environment. We have conservatively maintained their payout at S$0.06 for FY21e and FY22e, in-line with the absolute payout in FY20, which gives investor’s a dividend yield of 3.8%.
• BRC Asia’s final dividend for FY20 fell 60% vs FY19 as earnings declined 36% due to the headwinds in the construction industry last year. Despite this, BRC Asia still declared a special dividend of S$0.04, bringing the total dividend paid out to S$0.06 for FY20, translating to a payout ratio of about 68% (up from 59% for FY19).

BRC Asia - INVESTMENT MERITS

Record earnings expected for FY21e and FY22e.

• We expect record profit for BRC Asia in FY21e and FY22e at S$42mn and S$45mn respectively on the back of a general recovery in the construction sector. We estimate that construction activity has resumed to about 75% of pre-COVID 19 levels at the moment, and we expect this to go up to 80% by June 2021 as construction activities continue to resume island wide.

Construction demand is expected to recover to S$23.0bn to S$28.0bn in 2021 recovering from S$21.3bn for 2020,

• We see BRC Asia’s leadership position in the reinforced steel industry as best positioned for a construction sector recovery. According to BCA, construction demand is expected to recover from 2021. This will be supported by public residential developments and upgrading works, the developments at Jurong Lake District, the construction of new healthcare facilities and various infrastructure projects such as the construction of the Cross Island MRT.
• While construction of mega projects such as Changi Airport Terminal Five and the expansion of two Integrated Resorts has been delayed, we see the eventual resumption of construction for these projects as a future catalyst for the company.
• See report attached below for further analysis on outlook of construction sector.

Potential for dividend payout to recover from FY21e and FY22e.

• BRC Asia’s final dividend for FY20 fell 60% vs FY19 as earnings declined 36% due to headwinds in the construction industry last year. Despite this, the Group still declared a special dividend of S$0.04 for FY20, translating to a payout ratio of about 68% (up from 59% for FY19).
• Using the mid-point of the dividend payout ratio declared by the Group for FY19 and FY20, we think BRC Asia could potentially declare dividends of S$0.10 and S$0.11 for FY21e and FY22e as construction activity resume in Singapore.

BRC Asia - VALUATION

• We initiate coverage on BRC Asia with a BUY recommendation and target price of $1.87. Our target price is based on 11x FY21 P/E, a 15% discount to their historical average P/E on account of the uncertain environment.
• In our view, BRC Asia should trade at a higher premium to their historical P/E after the acquisition of Lee Metal in 2018 as this strengthened their market position considerably. Nonetheless, we remain cautious about the outlook for the industry as construction activity could remain subdued until a permanent solution for the pandemic is found.
• Near term, we believe the national effort to vaccinate the Singapore population could see a recovery of general economic activity and improve the outlook on the construction sector, reducing the discount to their historical average P/E.
• See BRC Asia Share Price; BRC Asia Target Price; BRC Asia Analyst Reports; BRC Asia Dividend History; BRC Asia Announcements; BRC Asia Latest News.

BRC Asia - RISKS

Resurgence of COVID-19 cases in Singapore and in the foreign workers dormitories.

• The prevention of a resurgence of COVID-19 cases will remain a primary concern in all economic activities. For the Singapore construction sector, regular swab tests for foreign workers residing in dormitories and worksite personnel help to ensure a safe working environment. However, a resurgence of COVID-19 cases in the dormitories could ground construction to a halt.

Failure to bring in new foreign workers to alleviate the labour crunch.

• Tighter border controls amid the coronavirus pandemic has seen a labour crunch in the construction sector. The Ministry of Manpower’s recent move to allow the return of existing work pass holders as well as entry into Singapore for new work pass holders will help alleviate the labour crunch in the construction industry. However, the high cost of ensuring the workers’ passage into Singapore could reduce the entry of foreign workers into Singapore, elevating the labour crunch.

See PDF report attached below for complete analysis on BRC Asia (SGX:BEC).

Terence Chua Phillip Securities Research | https://www.stocksbnb.com/ 2021-02-22

SGX Stock Analyst Report BUY MAINTAIN BUY 1.87 SAME 1.87