Dancomech Holdings Berhad Expansion to Cater for RAPID and East Malaysia. Fair Value: RM0.78 Main Market Listing. Not Rated

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1 A Member of the TA Group MENARA TA ONE, 22 JALAN P. RAMLEE, KUALA LUMPUR, MALAYSIA TEL: / FAX: IPO Monday, July 04, 2016 FBM KLCI: 1, Sector: Plantation Dancomech Holdings Berhad Expansion to Cater for RAPID and East Malaysia THIS REPORT IS STRICTLY FOR INTERNAL CIRCULATION ONLY* Fair Value: RM0.78 Main Market Listing Not Rated Abel Goon Tel: ext abelgoon@ta.com.my Company Background Dancomech Holdings Bhd (Danco) is primarily involved in the trading and distribution of process control equipment (PCE) and Measurement Instruments. The Group s major customers are from industries such as palm oil, oil and gas and water treatment. IPO Statistic The IPO will raise gross proceeds of RM18mn and constitutes a public issue of 24.0mn new ordinary shares at an issue price of RM0.75/share. There is also an offer for sale of 16.0mn shares to Bumiputera and selected investors. Investment Thesis 1. Demand increase from RAPID 2. Growing water services industry 3. Expected increase in demand from palm oil industry Key Risks 1. Dependency on major customers 2. Absence of long-term contracts 3. Forex and raw material prices fluctuations 4. Highly competitive market Valuation We fairly value Danco at RM0.78/share. This is pegged to 8x CY17 EPS which is the weighted average of Danco s peers, Unimech, Engtex and Pantech. Earnings Summary FYE Dec (RM mn) E 2017F 2018F Revenue EBITDA EBIT EBIT Margin (%) Net Finance Costs PBT Tax (5.2) (4.1) (4.4) (4.9) (5.2) PATMI Share Information Listing Main Market Enlarged Share Capital (mn) Market RM0.75 (mn) Par Value 0.40 Issue Price 0.75 Oversubscription rate N/A Estimated free float (%) 26.9 Tentative Listing Date 21-Jul-16 Tentative Listing Dates Event Opening of the IPO Closing of the IPO Balloting of Applications Allotment of Shares Listing Tentative Date 23-Jun Jul Jul Jul Jul-16 Ratio & Analysis NTA per share (post IPO)(sen) 61.0 Price to NTA (x) 1.2 Proforma Net Gearing (x) Net cash Utilisation of Proceeds RMmn % Capital expenditure Working capital Repayment of borrowings Est. listing expenses TOTAL EPS (sen) PER (x) DPS (sen) Dividend yield (%) Page 1 of 8

2 COMPANY OVERVIEW Dancomech Holdings Bhd (Danco) is primarily involved in the trading and distribution of process control equipment (PCE) and Measurement Instruments. The Group s major customers are from industries such as, palm oil (FY15: 59%), oil and gas (FY15: 14%) and water treatment (FY15: 5%). Danco s main product are PCE, which refers to equipment that provides appropriate signal transformation and direct a process according to those signals. PCE that the Group trades in, include Valves, switches, bursting discs, tank ball floats and orifice plates (full list in Appendix). Danco distributes its own brand products as well as third party brand products. Corporate Structure Company Dancomech Dancomech Engineering (100%) Optimis (55%) Dancomech JB (100%) Principal Activities Investment Holding Trading and distribution of third party brands and own brands of PCE, measurement instruments and MPTE. Provision of aftersales services Trading and distribution of third party brands and own brands of PCE, measurement instruments to water and sewerage industry Trading and distribution of third party brands and own brands of PCE, measurement instruments in Johor Provision of after-sales services in Johor Figure 1: Revenue by Product Category Figure 2: Revenue by Industry Measurement PCE Plantation O&G Water Others 100% 100% 90% 80% 70% 60% 50% 90% 92% 92% 91% 90% 80% 70% 60% 50% 23% 18% 19% 22% 3% 3% 4% 5% 15% 27% 19% 14% 40% 40% 30% 20% 30% 20% 59% 52% 58% 59% 10% 0% 10% 8% 8% 9% 10% 0% Source: Company, Source: Company, Figure 3: Revenue by Geography Figure 4: Revenue by Brand Malaysia Overseas Third party Own 100% 100% 90% 80% 28% 20% 22% 21% 90% 80% 36% 30% 32% 39% 70% 70% 60% 60% 50% 50% 40% 30% 72% 80% 78% 79% 40% 30% 64% 70% 68% 61% 20% 20% 10% 10% 0% 0% Source: Company, Source: Company, Page 2 of 8

3 IPO DETAILS Figure 5. IPO Structure Source: Company, Repaying Borrowings and Expanding The gross IPO proceeds totalling, RM18.0mn will mainly be used for capex to purchase new offices cum store in Johor, Sabah and Sarawak. Offices in Sabah and Sarawak would allow the Group to have greater presence in East Malaysia. Meanwhile, the new office in Johor will allow the Group to establish a base of operations closer to RAPID. Besides, Danco is setting up an assembly line, which would allow it to perform in-house customisation on its stainless steel flexible hose product that caters to the palm oil industry. Furthermore, Danco plans to partially repay bank borrowings taken from Public Bank, which would save interest costs. The remaining proceeds will be used for working capital requirement and listing expenses. Figure 6. Utilisation of IPO Proceeds Source: Company, Dividend Policy Danco has dividend policy of 30% payout ratio. Based on our earnings forecast and issue price, this presents a decent dividend yield of % in FY16- FY17, which is comparable to peers. Moratorium Period and Substantial Shareholders Post IPO completion, 73.15% of Danco s enlarged issued and paid-up capital will be owned by members of the Aik family via direct holdings or ABC Equity Sdn Bhd. All substantial shareholders are subjected to a 6-month moratorium. Furthermore, the substantial shareholders have agreed to a further 6-month voluntary moratorium on their shareholdings amounting to 51% of the nominal issued and paid-up ordinary share capital. INVESTMENT THESIS Demand increase from RAPID We believe the Group s expansion plans into Johor is a strategic move to leverage on the RAPID project at Pengerang. We gather that total capex for RAPID is expected to be circa RM57bn. Hence, demand for the Group s PCE products should increase, especially if they have a noticeable presence at the Page 3 of 8

4 site. Pantech, a company based in Johor that supplies pipes, valves and fittings expects to garner RM mn from RAPID. Growing water services industry In line with population growth in Malaysia, demand for clean water supply and wastewater management has increased. According to independent market report, the water service industry will continue to expand as population increases. Malaysian population is projected to reach 38.6mn by The government aims to provide 99% of the population with clean and treated water by Thus, we believe this will increase demand for Danco s PCE. Expected increase in demand from palm oil industry Production of fresh fruit bunches (FFB) in the palm oil industry is expected to increase with the end of El Nino. Also, companies in the industry are set to increase production to meet ever increasing demand for palm oil. For example, United Malacca recently carried out their maiden expansion into Indonesia acquiring circa 25k ha of palm oil plantations. Meanwhile, Sime Darby began planting higher yielding crop achieved via genome sequencing. Hence, to keep up with production of FFB, expansion in palm oil processing facilities is expected. This will have a positive spill over effect to the PCE and measurements market. KEY RISKS Dependency on performance of end user markets Danco s end users are: 1) palm oil players, 2) oil and gas companies and 3) water services providers. Any reduction of capex in these industries will impact the Group negatively. Note that Danco s revenue and profit has been on a downward trend for the past 2 years, which is in-line with the downturn in both palm oil and oil and gas industries. Also, recall that Petronas has reduced capex for 2016 by RM15-20bn, which may reduce demand for Danco s products. Absence of long-term contracts Danco has no long-term contracts with any of their customers. Majority of the sales made by the Group are purchased as and when its customers need arises. Hence, there are significant uncertainties in sales volume for the Group. This may have a negative impact on earnings. Fluctuations in raw material prices Danco purchases its PCE and measurement instruments from various third party suppliers based in Europe, China, and Taiwan. Any increase in prices of raw materials such as iron ore, natural gas and crude oil may increase Danco s costs as its suppliers pass on increased cost. If the Group is unable to increase its ASPs, earnings will experience some adverse effects. Highly competitive market The PCE and measurement instruments market is highly competitive due to a lack of barriers to entry. There is great number of different brands and companies with differing product range, price and customer service that can reliably substitute Danco s brands. Furthermore, no regulations are in place to prevent new players entering the market. We note that Danco had merely 2.9%/2.5% of total market share in FY14/FY15. Page 4 of 8

5 Figure 7: Danco Market Share (2014) Figure 8: Danco Market Share (2015) Danco, 2.9% Danco, 2.5% Others, 97.1% Others, 97.5% FINANCIALS Historical Danco experienced challenging times in FY14-FY15 in-line with the slowdown in the oil and gas and palm oil industries. Its earnings saw a 46% and 22% reduction for FY14 and FY15 respectively. According to management the bigger than expected reduction in profits in FY14 was due to increased cost as a result of change in technical specifications of the end user. This resulted in products being sent back for modification. In both years, the slowdown in the oil and gas and palm oil industries translated to lower sales volume for the Group. Furthermore, in an effort to maintain market share, it had to give discounts to its customers due to the competitive nature of the business. Figure 8: 4-year Historical Revenue Figure 8: 4-year Historical Net Profit RM mn RM mn Earnings Forecast We expect revenue to increase by 8.5%/12.1% in FY16/17. Revenue drivers will be 1) possible La Nina that would increase the need for palm oil processing facilities, 2) RAPID project in Johor to increase demand for PCE. Net profit will also see growth of 17.0%/12.8% as a result of the increased demand for the Group s products. VALUATION We compare Danco to companies that trade in PCE like valves such as, Pantech, Engtex and Unimech. We apply a target PE multiple of 8x CY17 EPS, at par with the weighted average PE multiple of its peer companies. Hence, we arrive at a fair value of RM0.78 for Danco. This offers a 4.0% potential upside to its IPO price of RM0.75/share. Page 5 of 8

6 Company Mkt Cap (RM mn) PE (x) Div. yield (%) ROE (%) EPS Growth (%) CY16 CY17 CY16 CY17 CY16 CY17 CY16 CY17 Pantech Unimech Group (9.1) 3.8 Engtex na na na na Weighted Average Dancomech Page 6 of 8

7 Appendix Process Control Equipment (PCE) Page 7 of 8

8 Measurement Instrument Mechanical Power Transmission Equipment (MPTE) Disclaimer The information in this report has been obtained from sources believed to be reliable. Its accuracy or completeness is not guaranteed and opinions are subject to change without notice. This report is for information only and not to be construed as a solicitation for contracts. We accept no liability for any direct or indirect loss arising from the use of this document. We, our associates, directors, employees may have an interest in the securities and/or companies mentioned herein. for TA SECURITIES HOLDINGS BERHAD (14948-M) MENARA TA ONE, 22 JALAN P. RAMLEE, KUALA LUMPUR, MALAYSIA TEL: / FAX: (A Participating Organisation of Bursa Malaysia Securities Berhad) Kaladher Govindan Head of Research Page 8 of 8