Dancomech Holdings Berhad Specialist in PCE and measurement instruments

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1 05 July 2016 IPO Note Dancomech Holdings Berhad Specialist in PCE and measurement instruments INVESTMENT HIGHLIGHTS Diverse income sources from various industries including oil & gas, plantation and water Wide range of product offerings from branded items to third party OEM Extensive list of suppliers in its stable Several in-house brands to drive and support growth Fair value of RM per share BUSINESS OVERVIEW Established in 1993, Dancomech mainly trades and distributes third party brands of process control equipment (PCE) and measurement instruments (60%-70% of sales) as well as its in-house brand products (30%-40%). It also provides testing and after-sale services, which is one of its key business proposition to keep its customers. The latest area it gets into is the heating, ventilation, air-conditioning, water filtration and fire-fighting business. Its main market is Malaysia, making up ~80% of its total sales in the past three years. INVESTMENT THESIS Diverse income sources. Dancomech has customers from palm oil, oleochemicals, oil and gas and petrochemical and water treatment and sewerage. It serves a customer base of 1,459 which include traders, distributors, EPCC (engineering, procurement, construction and commissioning) contractors, engineering consultants and OEM (original equipment manufacturer) hardware retailers. Generally, a single customer does not contribute up to 10% or more to its revenue. Wide range of products. The diverse products under Dancomech s belt provides cushion for any shortfall of sales from any particular product. As it obtains extensive agreements to resell brands from various third party OEMs, it is able to change its sales strategies according to the economic dynamics. For example, it will be focusing on marketing products in the water treatment and sewerage industry going forward as the industry provides much prospects. Opportunities could arise from the Selangor government s proposed water industry restructuring plan. For now, it carries 12 product categories under its process control equipment (PCE) division and 5 product categories under its measurement instruments division. RETURN STATS Indicative IPO Price Fair Value Expected Share Price Return 75 sen 76 to 91 sen Up to 21.3% Expected Dividend Yield 3.0% Expected Total Return Up to 24.3% STOCK INFO KLCI 1, Bursa / Bloomberg 5276 Board / Sector Syariah Compliant Main Market/ Trading Services No Issued shares (m) 149 Par Value (RM) 0.40 Market cap. (RM m) Tentative Dates Prospectus Launch June 23 Closing of application for IPO shares July 12 Balloting of IPO shares July 14 Allotment of shares to successful applicants July 20 Listing July 21 Major Shareholders (%) ABC Equity Aik Swee Tong 6.63 Aik Cwo Shing 6.63 Aik Kwo Liang 4.11 Wong Chiau Siew 3.79 is a unit of MIDF AMANAH INVESTMENT BANK Kindly refer to the last page of this publication for important disclosures

2 2 Extensive list of suppliers and long relationships with them. Dancomech gets its products from several major suppliers from China, Germany, Taiwan and the UK. That will reduce its reliance on one sole supplier. Over the past few years, the four major suppliers, namely Neway Valve (Suzhou) Co Ltd, Leser GmbH & Co Kg/ Lesser LLP, Valveline Industrial Co Ltd and British Rototherm Co Lt, supplied 43.66% to 52.66% of Dancomech s products. The relationships established with these suppliers range from years. Besides that, it is also the sole distributor, exclusive agent and authorised dealers for numerous products. Substantial sales from in-house brands. On top of the wide product range offerings, Dancomech sells its inhouse brands, namely WAGI, VMX and Omaval. Altogether, they contributed RM24.95m or 29.99% of FY13 revenue, RM25.1m or 31.77% of FY14 revenue, and RM26.64m or 39.02% of FY15 revenue. The increasing higher contribution of the in-house brand suggests that Dancomech s products are well-received. Going forward, the group will continue to grow its in-house brand offering. We view this positively as it will have more control over the costs and margins of its own products. It outsources the manufacturing of the in-house brands to overseas third party suppliers and OEMs. Viable expansion plans. The group intends to set up new offices in Johor, Sabah and Sarawak. An office-cum-store in Johor Bahru is planned to cater for the potential demand growth from the activities at RAPID, Pengerang. It also aims at setting up offices in Bintulu, Sarawak and Lahad Datu, Sabah to enhance its services to its customers. These locations are identified because they are considered the centre of palm oil and oleochemicals as well as O&G petrochemical business activities. Topping that, it targets to further expand its product range as well as to expand into more oversea markets when opportunities present. In the past three years, its main overseas market is Indonesia, contributing 17%-20% to its sales. These plans are positive for the company as they do not require high capex. Dividend payout of up to 30% of profit probable backed by high growth of cashpile. As at LPD, the group s gross gearing level is healthy at 0.11 times. It is also sitting on a pre-ipo sizeable cashpile of RM27.9m, which translates into 18.7sen per share. Post-listing, it will be in a net cash position (after paring down borrowings and listing expenses) of RM40.1m. Based on the assumption of a 30% payout, we are estimating a dividend yield of approximately 3% in FY17F. Interestingly, Dancomech s cash and cash equivalents have been growing steadily in the past 3 years, with a CAGR of +19.1% from FY13-FY15. The company s profit recorded a jump of +69% in FY13 partially due to a one-off gain of RM8.44m from disposal of assets. Stripping off the one-off gain, earnings rose only by +14%yoy, which is still commendable. PBT margins held above 20% from FY13 to FY15. Dancomech s PBT margins have ranged from 22.50% to 38.46% in the past three years. That is much higher compared to some of its peers. For example, Pantech Group Holdings Bhd, had registered PBT margins that ranged from 10.86% to 13.07% from FY12 to FY15. Another peer, Unimech Group Bhd recorded PBT margins between 8.63% and 15.51% in the same period. However, we note that the business nature of these two peers is still somewhat different from Dancomech due to the specific products that they make and sell. Pantech sells valves, steel fittings and pipes mainly to the O&G industry while Unimech sells valves, pipe fitting and boiler parts. We gather that one of the reasons Dancomech is able to get higher margins is that it provides value-added services such as assembling different parts to make a higher-functioning component, testing and customisation. Some of the products it trades are highly specialised, which is why it is able to command better pricing. Stabilising commodity prices to support growth in the industries it is exposed to. The recovery of CPO prices in the first few months of the year bodes well for the company as 59.13% of its revenue comes from customers in the palm oil and oleochemicals industry. Following that, Dancomech derives 13.7% of its revenue from customers in the O&G and petrochemicals industry. Brent crude, for instance, found a ground that ranges from USD47 per barrel to USD50 per barrel. The stabilising and improving commodity prices could lead to a steadier stream of investment activities by industry players, which in turn will have a positive spillover for Dancomech.

3 3 VALUATION Fair value range of RM0.76 to RM0.91 based on FY17F EPS of 7.58sen. We derived the fair value range of RM per share from a PER range of 10x to 12x. This range is within the FBM Small Cap Index s 5-year historical PE band of between a low of 7.39x and a high of 29.94x. The index s average PER for the 5-year period was 14.74x. As for its Malaysian peers, Unimech Group Bhd (market cap ~RM141m) is trading at a forward PER of 14.75x while Pantech Group Holdings Bhd (market cap ~RM354m) is trading at a forward PER of 8.3x. We note that Unimech and Pantech have different profiles when it comes to their industrial exposure while they also manufacture their own products. Hence, the PER of 10x to 12x times is justified based on Dancomech s healthy financial position and viable expansion plans, which will in turn provide growth prospects. The proposed dividend plan will be a sweetener for shareholders. INVESTMENT STATISTICS FYE Dec (RM m) FY13 FY14 FY15 FY16F FY17F Revenue Gross profit Profit Before Tax Profit After Tax EPS (sen) PER EPS growth (%) NA Dividend (sen) Dividend yield (%) Source: Company, MIDR Research Aaron Tan Wei Min Ng Bei Shan ng.bs@midf.com.my

4 4 UTILISATION OF PROCEEDS Purpose Amount (RM m) Percentage (%) Estimated Timeframe Purchase of offices cum stores Within 24 months Repayment of bank borrowing Within 12 months Purchase of equipment Within 12 months Estimated listing expenses Upon listing Working capital Within 24 months TOTAL Source: MIDFR, Prospectus Of the RM6.5m allocated for the purchase of offices cum stores, RM2.5m will be used for the setup of its Johor Bahru office. The remaining RM4m will be used for the expansion of its market presence in Sabah and Sarawak. It has also set aside RM4.56m to repay an outstanding fixed loan of about RM7.85m, which was undertaken to part finance the construction of its current main office. It also intends to use RM500,000 of the proceeds to upgrade its testing lab with the aim to become a Leser Authorised Repair Center eventually. Dancomech notes that it will have to meet with Leser s qualification for that and that the status will give it a competitive advantage that will further enhance its after sales service. It also plans to set up a stainless steel flexible hose assembly line by using the remaining RM500,000. With the new line, Dancomech will be able to customise the stainless steel flexible hose products to meet its customers requirements. INDUSTRY OVERVIEW Dancomech commands a market share of 3-5% in Malaysia as the overall market is fragmented. The recent improvement in prices of commodities like crude oil and crude palm oil should have a positive spillover to Dancomech. The company s growth prospects are tied to the outlook of these two sectors. According to an IMR report, the market size for the process control equipment and measurement instrument market for industrial pipeline systems in Malaysia is RM2.17b in It is expected to grow 2% to RM2.22b in 2016, +3.1% to RM2.29b in 2017 and +3.4% to RM2.36b in The CAGR for the market is 3.2% from 2016 to KEY RISKS Sectoral risks are inherent to Dancomech s businesses. As the group is highly exposed to the 2 main commodities- CPO and crude oil (contributing 72.83% to Dancomech s FY15 revenue collectively) softness in these two sectors will impact its prospects negatively. But any slowdown in sales growth might be cushioned by maintenance work in these industries. This is due to the wear and tear of parts, which will provide some earnings visibility for the group. Although the company has substantial exposure to the O&G industry, it supplies to the downstream sector, which has proved to be profitable for oil majors. For instance, Petronas downstream earnings had jumped +50%yoy due to cheaper feedstocks. In fact, the national O&G had placed more emphasis on the downstream operations due its profitability. As such, we believe there will still be opportunities in the downstream O&G segment. As for the plantation industry, Dancomech supplies to many upstream millers that process palm oil fruits into CPO. The group should be able to get businesses underpinned by the upward trend in CPO production over the past few years (from 18.8 million tonnes in 2012 to 20 million tonnes in 2015). That said, the palm oil industry value chain is extensive from upstream to various downstream refining and processing sub-segments. We understand that Dancomech supplies equipment and products to these various sub-segments.

5 5 Bumpy earnings. While huge projects bode well for Dancomech s earnings, one of the main reasons it saw a strong growth in FY13 top and bottomline is due to the large order it secured from KNM Group. Orders from KNM Group contributed approximately 15% or RM12.48m to Dancomech s FY13 revenue. For FY14, earnings fell by 46% due to the absence of a big order. On the flipside, the group does not rely on any single major customer for its revenue. That is because none of its single customer contributes up to 10% or more to its topline generally. The company does not have long-term contracts with its customers. Forex risks. The volatility of foreign exchange rates in recent times may hurt Dancomech s earnings as it trades with third party OEMs from different countries. As at LPD, ~20% of its sales is international sales while 82% of its purchases are imported stocks quoted in USD, Euro, Pound Sterling, renminbi and Singapore dollars. Note that most of its purchases are denoted in USD. The group has taken measures such as operating foreign currency accounts in USD and Euro so that it does not have to convert the currencies when it receives the payment to mitigate risks. It holds fixed deposits in USD (10% of its cash in 2015) and GBP (1.17% of its cash in 2015) as part of its hedging strategy especially for delivery of products that spans over a period of time. Based on its historical forex sensitivity analysis, weaker Euro and GBP could potentially benefit the company. Above all, we believe that Dancomech will be able to pass on some of its costs to its customers in the event of a huge exchange rate fluctuation. Foreign Currency sensitivity analysis 2015 RM 2014 RM 2013 RM Euro/RM USD/RM GBP/RM SGD/RM RMB/RM Strengthened 10% (214,593) (316,696) (421,246) Weakened 10% 214, , ,246 Strengthened 10% 311, ,130 (3,128) Weakened 10% (311,593) (149,130) 3,128 Strengthened 10% (10,720) (120,439) (53,490) Weakened 10% 10, ,439 53,490 Strengthened 10% (2,140) (2,535) 2,612 Weakened 10% 2,140 2,535 (2,612) Strengthened 10% - (14,080) - Weakened 10% - 14,080 - Source: Prospectus

6 6 FINANCIAL STATEMENTS Income Statement (RM m) F 2017F Balance Sheet (RM m) F 2017F Revenue PPE Cost of Good Sold Others Gross Profit Non-current Asset Profit Before tax Inventory Tax expense Receivables Net Profit Others Earnings per share (sen) Cash Dividend per share (sen) Current Asset PER (x) TOTAL ASSETS Share capital Cash Flow Statement (RM m) F 2017F Reserves PBT Others Depreciation Shareholder's Fund Finance cost NCI Others TOTAL EQUITY OP before in WC Borrowings in inventory Others in receivables Non-current liabilities in payables Payables Cash from Ops Borrowings Interest expenses Others Tax Current liabilities Cash from Operations TOTAL LIABILITIES Puchase of PPE Others Ratios F 2017F Cash from Investment Profitability ratios (%) Return on Equity Net Borrowings Return on Assets Others Liquidity ratios (x) Dividends Current ratio Cash from Financing Quick ratio Net debt-to-equity net cash in cash Profit margin (%) FOREX & Disposals Gross margin Beginning cash PBT Margin Ending Cash Net profit margin Source: MIDFR, Prospectus

7 7 APPENDIX- Various Dancomech products NEWAY Ball Valve NEWAY Butterfly Valve REMBE Bursting Disc CRANE Flowseal

8 8 is part of MIDF Amanah Investment Bank Berhad ( X). (Bank Pelaburan) (A Participating Organisation of Bursa Malaysia Securities Berhad) DISCLOSURES AND DISCLAIMER This report has been prepared by MIDF AMANAH INVESTMENT BANK BERHAD (23878-X). It is for distribution only under such circumstances as may be permitted by applicable law. Readers should be fully aware that this report is for information purposes only. The opinions contained in this report are based on information obtained or derived from sources that we believe are reliable. MIDF AMANAH INVESTMENT BANK BERHAD makes no representation or warranty, expressed or implied, as to the accuracy, completeness or reliability of the information contained therein and it should not be relied upon as such. This report is not, and should not be construed as, an offer to buy or sell any securities or other financial instruments. The analysis contained herein is based on numerous assumptions. Different assumptions could result in materially different results. All opinions and estimates are subject to change without notice. The research analysts will initiate, update and cease coverage solely at the discretion of MIDF AMANAH INVESTMENT BANK BERHAD. The directors, employees and representatives of MIDF AMANAH INVESTMENT BANK BERHAD may have interest in any of the securities mentioned and may benefit from the information herein. Members of the MIDF Group and their affiliates may provide services to any company and affiliates of such companies whose securities are mentioned herein This document may not be reproduced, distributed or published in any form or for any purpose. MIDF AMANAH INVESTMENT BANK : GUIDE TO RECOMMENDATIONS STOCK RECOMMENDATIONS BUY TRADING BUY NEUTRAL SELL TRADING SELL Total return is expected to be >15% over the next 12 months. Stock price is expected to rise by >15% within 3-months after a Trading Buy rating has been assigned due to positive newsflow. Total return is expected to be between -15% and +15% over the next 12 months. Total return is expected to be <-15% over the next 12 months. Stock price is expected to fall by >15% within 3-months after a Trading Sell rating has been assigned due to negative newsflow. SECTOR RECOMMENDATIONS POSITIVE NEUTRAL NEGATIVE The sector is expected to outperform the overall market over the next 12 months. The sector is to perform in line with the overall market over the next 12 months. The sector is expected to underperform the overall market over the next 12 months.