Deleum Bhd
(Aug 23, 86 sen)
Downgrade to neutral with a lower target price (TP) of 84 sen: Deleum Bhd’s second quarter ended June 30, 2019 (2QFY19) earnings contracted by -5.6% year-on-year (y-o-y) to RM8.7 million. This brings its first half of financial year 2019 earnings to RM11.5 million which makes up 32.8% of our and 28.8% of consensus full-year forecasted FY19 (FY19F) earnings estimate respectively.

 
The weaker earnings were mainly attributable by: i) downward pressure on margins; and ii) less favourable exchange rate of ringgit to US dollar which has resulted in a net foreign exchange loss of RM1.9 million as opposed to a net gain of RM800,000 in the same period last year.

That said, revenue surged by +52.3% y-o-y during the quarter driven by higher revenue contribution coming from its integrated corrosion solutions segment which stems mainly from its maintenance, construction and modification (MCM) project.

Power and machinery (P&M) segment revenue grew by +20.8% y-o-y due to higher work orders secured for exchange engines, valves and flow regulator services and higher revenue contribution from retrofit projects due to increase in project hardware deliveries.

However, this was offset by the weaker work orders for turbine parts and repair, decrease in commission income earned on oil and gas projects and lower sales from third party and other ancillary services.

Meanwhile, profit contracted by -44.5% y-o-y due to unfavourable change in sales mix, downward pressure on margins as well as unfavourable exchange rate.

Oilfield services (OS) segment revenue increased by +27.4% y-o-y due to stronger work orders from well intervention and enhancement services as well as increase in slickline services work orders in the East Malaysia region. However, this was offset by lower slickline activities in West Malaysia region.

Segment profit fell to a loss during the quarter to -RM2.6 million due to downward pressure on margins, losses from its overseas slickline operations as well as adverse results in production optimisation and flow assurance operations.

Integrated corrosion solutions segment revenue surged by +168.1% y-o-y to RM76.2 million (from RM47.8 million in 2QFY18) due to the robust activity levels from its ongoing projects with higher sales revenue generated from the MCM services.

Additionally, there is also a pick-up in the sales from its sponge-jet blasting business following the renewal of Pan Malaysia Painting and Blasting Contract (PMPBC). The segment has also finally staged a turnaround during the quarter with a profit before tax of RM8.7 million which was mainly due to better sales mix and higher margins earned from is MCM and PMPBC contracts.

We are lowering our FY19F to FY20F earnings estimates by -13.2% and -4.4% to RM30.3 million and RM37.3 million respectively as we opine that margin compression on its P&M and OS segments as well as challenging operating environment for its OS segment will continue to drag down earnings.

Post-earnings adjustments, we are downgrading our recommendation on Deleum to “neutral” with a lower TP of 84 sen per share. Our TP is premised on price-earnings ratio 20 of 9 times pegged at earnings per share 20 of 9.3 sen.

We opine this is fair given that we do not foresee the margin compression for two of its segments which are: plant and machinery as well as oilfield services to recover in the near future. Furthermore, its order book replenishment has been slower-than-anticipated which results in lower future earnings visibility.

That said, we opine that Deleum’s niche in providing slickline services, turbine repairs and integrated corrosion solutions will remain as its key strength going forward which would place it at the forefront to win future contracts in these areas. — MIDF Research, Aug 23