Nam Cheong Ltd (LHS) Singapore Company Focus BUY S$0.41 STI : 3, Setting a scorching pace. DBS Group Research. Equity 12 Nov 2014

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1 Singapore Bloomberg: NCL SP Reuters: NMCG.SI Refer to important disclosures at the end of this report DBS Group Research. Equity 12 Nov 2014 BUY S$0.41 STI : 3, Price Target : 12-Month S$ 0.60 (Prev S$ 0.52) Reason for Report : Changes in earnings and TP Potential Catalyst: Better-than-expected dividends, order wins DBS vs Consensus: Largely in line Analyst Suvro SARKAR suvro@dbs.com Price Relative S$ 0.1 Aug-12 Jan-13 Jun-13 Nov-13 Apr-14 Sep-14 (LHS) Relative Index Relative STI INDEX (RHS) Forecasts and Valuation FY Dec (RM m) 2012A 2013A 2014F 2015F Revenue 877 1,257 1,869 2,156 EBITDA Pre-tax Profit Net Profit Net Pft (Pre Ex.) EPS (S cts) EPS Pre Ex. (S cts) EPS Gth (%) EPS Gth Pre Ex (%) Diluted EPS (S cts) Net DPS (S cts) BV Per Share (S cts) PE (X) PE Pre Ex. (X) P/Cash Flow (X) 26.8 nm EV/EBITDA (X) Net Div Yield (%) P/Book Value (X) Net Debt/Equity (X) ROAE (%) Earnings Rev (%): Consensus EPS (S cts): Other Broker Recs: B: 8 S: 0 H: 1 ICB Industry : Oil & Gas ICB Sector: Oil Equipment; Services & Dist Principal Business: Leading Malaysian builder of offshore support vessels Source of all data: Company, DBS Bank, Bloomberg Finance L.P Setting a scorching pace 3Q14 results significantly above expectations on better margin delivery Remains largely unaffected by near-term oil price weakness owing to its shallow water focus and fuel-efficient vessel designs Revise up FY14/15 EPS estimates by 27%/23% Maintain BUY with higher TP of S$0.60, pegged to 10x FY15 earnings Record quarter. 3Q14 net profit was up 113% y-o-y and 100% q- o-q to RM126m in 3Q14, significantly better than our estimates. This is Nam Cheong s strongest quarter to date since its listing in Revenue was up 81% y-o-y to RM619m as the company secured vessel sales contracts for 16 vessels during the quarter. For 9M14, net profit of RM260m is already close to existing consensus estimates for full-year FY14. The outperformance was driven by superior shipbuilding gross margin of 24% in 3Q14, as well as low marketing expenses. Gross margins were boosted by sales of vessels closer to delivery dates at higher premiums than usual. Vessel sales momentum intact despite falling oil prices. YTD in 2014, Nam Cheong has secured sales contracts for 25 vessels worth US$505m, another record year. Order book remains healthy at RM1.9bn, implying about 1x book-to-bill, decent for a so-called "speculative" shipbuilder. So far, it has sold 27 out of 30 vessels scheduled for delivery in 2014 and 14 out of the 35 vessels scheduled for delivery in In addition, Nam Cheong has also recently secured LOIs for 12 vessels (+8 options) worth US$186m for its proprietary designed diesel-electric AHTS vessels launched in October, which are earmarked for delivery in 2016 and beyond. Raise earnings, maintain BUY. We raise our earnings estimates for Nam Cheong by 27% and 23% for FY14/15 respectively; as we believe we were previously too conservative on margins and revenue recognition. Maintain our BUY call on Nam Cheong with a higher TP of S$0.60, as we roll over valuations to FY15. We reckon the share price decline in recent weeks amidst oil price weakness is an overreaction and offers a good entry point for the long term, as Nam Cheong goes from strength to strength. Its share price is well supported by a decent dividend yield of 3.7%, based on 25% payout ratio. At A Glance Issued Capital (m shrs) 2,100 Mkt. Cap (S$m/US$m) 861 / 667 Major Shareholders SK Tiong Enterprise Sdn (%) 27.4 Hung Yung Enterprise Sdn (%) 15.3 Su Kouk Tiong (%) 8.6 Free Float (%) 48.7 Avg. Daily Vol.( 000) 7,899 ed: TH / sa: JC

2 INVESTMENT THESIS Profile Nam Cheong has evolved over the years into Malaysia's largest builder of offshore support vessels (OSVs). Nam Cheong owns one main yard in Miri (Sarawak, Malaysia) and has tie-ups with a few state-owned yards in Fujian province, China. The bulk of its vessels are on built-to-stock basis, and they are marketed and sold about 3 to 9 months ahead of completion. Rationale Beneficiary of Malaysia's protected market Poised to benefit from an increase in capex by national oil company Petronas. Existing cabotage regulations in Malaysia and strong relationships with Malaysian owners/charterers put Nam Cheong in a strong position to supply OSVs to the market. Vessel sales momentum upbeat FY14 has turned out to be another record year for vessel sales contracts. Gross orderbook is around RM1.9bn, revenue visibility is around one year. Limited impact of lower oil prices Caters to shallow water market only, which is relatively unaffected by volatility in oil prices Owners will look to buy outright from built-to-stock players like Nam Cheong first instead of waiting one to two years to order a newbuild vessel from scratch. Valuation We have a BUY call on Nam Cheong with a target price of S$0.60 per share, based on 10x FY15 earnings. This is based on mid-cycle valuation metrics. Given the asset-light structure, Nam Cheong is able to generate very healthy ROEs of close to 25%, significantly better than peer average. Expected earnings CAGR of 26% over FY13-15 is also attractive. Risks Business model carries higher risks Failure to read the market correctly will result in unsold inventory. High working capital requirements of the business model can stress balance sheet, if not managed well. Increasing competition Chinese yards have spare capacity and are moving up the value chain into more sophisticated OSVs. The key barrier to entry is the branding and industry contacts, which established yards like Nam Cheong have. Source: DBS Bank Page 2

3 FY14 another record year for vessel sales contracts. In FY14, the Group has concluded sales contracts for 25 vessels worth more than US$500m to a mix of repeat and new customers in Malaysia, rest of SE Asia, Africa and Europe. Nam Cheong s gross orderbook now stands at about RM1.9bn, which includes, apart from the built-to-stock series, eight ERRVs for deployment in the North Sea, four MPSVs for Bumi Armada and two AWBs for Perdana Petroleum secured on a built-toorder basis. These 14 built-to-order vessels will be delivered progressively over FY In addition, Nam Cheong has secured LOIs for 12 vessels (+8 options) worth US$186m for its proprietary designed diesel-electric AHTS vessels launched in October, which are earmarked for delivery in 2016 and beyond. Best year for order intake for Nam Cheong Year No. of vessels Total value (RM m) Avg/vessel (RM m) , YTD Source: Company Vessel sales contracts secured YTD in FY14 Date Buyer Country Value (US$m) Vessels Yard Status 28-Jan Sentinel Marine UK ERRV China Estimate to deliver in 2015/16 28-Jan Sentinel Marine UK AHTS China Estimate to deliver in 2015/16 31-Mar Multi Marine Malaysia AHTS China Mar E.A. Temile West Africa PSV China Jun Perdana Petroleum Malaysia AWB China Jul Undisclosed Asia PSV China Jul Maridive & Oil Services North Africa AWB China Aug Various Malaysia, Indonesia, Vietnam PSV, 2 AHTS, 1 AWB China Sep BBR Indonesia OSVs China Sep Various Europe, Asia AHTS China 2014 Total Status of 2014 Built-to-stock portfolio Status of 2015 Built-to-stock portfolio AHTS PSV AWB AHTS PSV AWB Unsold Sold Delivered Unsold Sold Page 3

4 Nam Cheong launched new proprietary AHTS vessel design recently Length 64.8m Bollard Pull 80 tonnes Features: Diesel-electric propulsion Dynamic positioning 2 (DP 2) Class: ABS Nam Cheong recently unveiled its proprietary designed AHTS vessel in Singapore. Tagged as the NCA80E series, the vessel is a 64.8-m diesel electric powered 6,000-bhp AHTS with 80 tonnes bollard pull. The NCA80E vessel boasts an energyefficient design and is equipped with selected electric drives which lead to lower fuel consumption without a loss in power. According to management, the vessel has been Asianised to allow for an efficient building process to reduce delivery time and yet, be flexible enough in its capabilities to be deployed in multiple roles. We believe the vessel is targeted to meet requirements from oil majors who seek to use newer vessels which consume less fuel. New design well taken up by market. Nam Cheong has secured Letters Of Intent (LOI) worth approximately US$186m from five customers, with a mix of sale and charter of 12 NCA80E vessels. The Group has also secured options for the sale of eight additional NCA80E vessels. The five customers are Bumi Armada, Geooffshore Pte Ltd, Opstad Group, Sofield Marine & Offshore and Vega Offshore Group. The potential sale of the 20 vessels through the LOIs and options represent a 100% take-up rate of the 20 vessels planned for delivery. The LOIs are expected to be firmed up by 1Q15, while the options have a 6-month validity period. These will be delivered in 2016 and beyond. Take-up of Nam Cheong s NCA80E series of AHTS vessels Customer Country No of Vessels Status Bumi Armada Malaysia 4 Letter of Intent 4 Options Vega Offshore Norway 2 Letter of Intent Geooffshore Singapore 4 Letter of Intent 4 Options Opstad Group Norway 1 Letter of Intent Sofield Marine Malaysia 1 Letter of Intent Page 4

5 3Q14 Results Summary and Comparison FY Dec (RM m) 3Q13 4Q13 3Q14 YoY Chg QoQ Chg Sales % 63% Cost of Goods Sold (253.9) (311.9) (469.9) 85% 51% Gross Profit % 122% Other Operating Income % -85% Distribution Costs Administration Expenses (22.5) (8.9) (14.9) -34% 67% R & D and other expenses Other Operating Expenses (22.5) (8.9) (14.9) -34% 67% EBIT % 105% Non-Operating Income Interest Income Interest Expense (1.5) (3.8) (7.5) 393% 96% Share of Associates' or JV Income Exceptional Gains/(Losses) Pretax Profit % 102% Tax (4.3) (1.1) (4.0) -6% 253% Minority Interests Net Profit % 100% Margins (%) Gross Margin EBITDA Margin EBIT Margin Pre-tax Margin Net Margin Page 5

6 Key Assumptions FY Dec 2011A 2012A 2013A 2014F 2015F # AHTS delivered # PSV delivered # AWB delivered # BTO vessels delivered Segmental Breakdown FY Dec 2011A 2012A 2013A 2014F 2015F Revenues (RM m) Shipbuilding ,192 1,789 2,076 Chartering Total ,257 1,869 2,156 Gross profit (RM m) Shipbuilding Chartering Total Gross profit Margins (%) Shipbuilding Chartering Margins diluted to an extent by built-to-order vessels Total Income Statement (RM m) FY Dec 2011A 2012A 2013A 2014F 2015F Revenue ,257 1,869 2,156 Cost of Goods Sold (468) (688) (993) (1,485) (1,746) Gross Profit Other Opng (Exp)/Inc (33) (45) (57) (46) (57) Operating Profit Other Non Opg (Exp)/Inc Associates & JV Inc Net Interest (Exp)/Inc (5) (8) (11) (20) (26) Exceptional Gain/(Loss) Pre-tax Profit Tax (8) (2) 7 (7) (7) Minority Interest 0 0 (1) 0 0 Preference Dividend Net Profit Net Profit before Except EBITDA Growth Revenue Gth (%) (20.0) EBITDA Gth (%) (16.8) Opg Profit Gth (%) (19.0) Net Profit Gth (%) (22.0) Margins & Ratio Gross Margins (%) Opg Profit Margin (%) Net Profit Margin (%) ROAE (%) ROA (%) ROCE (%) Div Payout Ratio (%) Net Interest Cover (x) Margins Trend 20.0% 19.0% 18.0% 17.0% 16.0% 15.0% 14.0% 2011A 2012A 2013A 2014F 2015F Operating Margin % Net Income Margin % Higher borrowings (MTN issues) to support bigger builtto-stock shipbuilding programme Fair value gains on derivatives in FY14 Page 6

7 Quarterly / Interim Income Statement (RM m) FY Dec 3Q2013 4Q2013 1Q2014 2Q2014 3Q2014 Revenue Cost of Goods Sold (254) (327) (321) (312) (470) Gross Profit Other Oper. (Exp)/Inc (22) (22) (12) (1) (14) Operating Profit Other Non Opg (Exp)/Inc Associates & JV Inc Net Interest (Exp)/Inc (2) (3) (4) (4) (8) Exceptional Gain/(Loss) Pre-tax Profit Tax (4) 12 0 (1) (4) Minority Interest Net Profit Net profit bef Except EBITDA Growth Revenue Gth (%) (7.0) 63.3 EBITDA Gth (%) 52.4 (7.1) 22.2 (9.1) 96.0 Opg Profit Gth (%) 48.9 (11.0) 28.7 (11.8) Net Profit Gth (%) (11.0) 99.5 Margins Gross Margins (%) Opg Profit Margins (%) Net Profit Margins (%) Revenue Trend Q2012 3Q2012 4Q2012 Revenue 1Q2013 2Q2013 3Q2013 4Q2013 1Q2014 2Q2014 Revenue Growth % (QoQ) Significantly higher-thannormal run rate of profits 3Q % 150% 100% 50% 0% -50% Balance Sheet (RM m) FY Dec 2011A 2012A 2013A 2014F 2015F Net Fixed Assets Invts in Associates & JVs Other LT Assets Cash & ST Invts Inventory Debtors Other Current Assets Total Assets 961 1,306 2,179 2,974 3,292 ST Debt Creditor Other Current Liab LT Debt ,109 1,109 Other LT Liabilities Shareholder s Equity ,183 1,429 Minority Interests Total Cap. & Liab ,306 2,179 2,974 3,292 Asset Breakdown (2013) Inventory % Debtors % Net Fixed Assets % Assocs'/JVs - 0.1% Bank, Cash and Liquid Assets % Non-Cash Wkg. Capital ,051 1,329 1,502 Net Cash/(Debt) (299) (226) (489) (569) (542) Debtors Turn (avg days) Creditors Turn (avg days) Inventory Turn (avg days) Asset Turnover (x) Current Ratio (x) Quick Ratio (x) Net Debt/Equity (X) Net Debt/Equity ex MI (X) Capex to Debt (%) Z-Score (X) NA Gearing expected to remain well below 1.0x, even with higher capital commitments Page 7

8 Cash Flow Statement (RM m) FY Dec 2011A 2012A 2013A 2014F 2015F Pre-Tax Profit Dep. & Amort Tax Paid (9) (5) 0 0 (7) Assoc. & JV Inc/(loss) (2) (3) (3) (8) (8) Chg in Wkg.Cap. (52) (63) (419) (285) (173) Other Operating CF (8) 1 (21) 0 0 Net Operating CF (231) Capital Exp.(net) (7) (6) (36) (50) (50) Other Invts.(net) 0 0 (79) 0 0 Invts in Assoc. & JV 0 (4) (2) 0 0 Div from Assoc & JV Other Investing CF Net Investing CF (7) (10) (117) (50) (50) Div Paid 0 (9) (26) (82) (82) Chg in Gross Debt (59) Capital Issues Other Financing CF 4 (10) (1) 0 0 Net Financing CF (55) (82) Currency Adjustments Chg in Cash (22) Opg CFPS (sen) Free CFPS (sen) (12.8) Capital Expenditure A 2012A 2013A 2014F 2015F Capital Expenditure (-) Dividend payout ratio of 25% assumed Target Price & Ratings History S$ S.No. Date Closing Ta rge t Price Price Rating 1: 29 Nov Buy 2: 28 Jan Buy 3: 25 Mar Buy 4: 16 May Buy 5: 10 Jun Buy 6: 09 Jul Buy 7: 11 Aug Buy 8: 30 Sep Buy Nov-13 Mar-14 Jul-14 Nov-14 Note : Share price and Target price are adjusted for corporate actions. Source: DBS Bank Page 8

9 DBS Bank recommendations are based an Absolute Total Return* Rating system, defined as follows: STRONG BUY (>20% total return over the next 3 months, with identifiable share price catalysts within this time frame) BUY (>15% total return over the next 12 months for small caps, >10% for large caps) HOLD (-10% to +15% total return over the next 12 months for small caps, -10% to +10% for large caps) FULLY VALUED (negative total return i.e. > -10% over the next 12 months) SELL (negative total return of > -20% over the next 3 months, with identifiable catalysts within this time frame) Share price appreciation + dividends GENERAL DISCLOSURE/DISCLAIMER This report is prepared by DBS Bank Ltd. 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