KUALA LUMPUR (Sept 14): Hong Leong Investment Bank (HLIB) Research has initiated coverage of Serba Dinamik Holdings Bhd at RM1.70, with a "buy" rating, and said it is one of the few oil and gas (O&G) related stocks that are relatively insulated from volatility in oil prices with a strong earnings track record.

In a research note today, the research firm placed a target price (TP) of RM2.50 on Serba, adding that its TP is based on earnings per share (EPS) of 18.4 sen forecast for the financial year ending Dec 31, 2021 (FY21F) pegged at a price-earnings (P/E) multiple of 13.5 times, which is its three-year mean P/E. 

“Our TP implies an upside potential of almost 50%, including dividends, and we believe this is justified as it is likely that Serba would be able to maintain its high margins amid the weak O&G market. 

“Serba currently has the highest EBIT (earnings before interest and taxes) margins for O&M (operations and maintenance) in Malaysia, and the recurring nature of its O&M contracts and rapidly growing EPCC (engineering, procurement, construction and commissioning) order book would ensure earnings sustainability in the foreseeable future,” said HLIB analyst Low Jin Wu. 

Low noted that Serba’s current order book of RM18.5 billion is mainly underpinned by its RM7.7 billion innovation hub contract (EPCC) win from Block 7 LLC (LIWA Petroleum) in the United Arab Emirates (UAE), saying that the research firm expects the group to experience a compound annual growth rate (CAGR) of 37% for FY20F-FY22F due to its large order book backlog.

Furthermore, Low views that Serba’s stature as a “Sarawak company” would open up more opportunities for them. 

“Recall that most MCM/HUC/plant turnaround contracts were predominantly awarded to Sarawak-based companies, and this trend is expected [to] continue when Petronas (Petroliam Nasional Bhd) decides to elevate its capex (capital expenditure) spending. 

“We forecast Serba's FY20 core earnings to come in at RM556.6 million (+12% year-on-year or y-o-y), a very commendable return in spite of the volatile and weak O&G market. 

"We believe that Serba’s earnings would peak in FY22 when its Block 7 contract goes through its peak earnings phase in FY22. We forecast profit to grow by about 12%/12%/28% for FY20F- FY22F, implying a three-year CAGR of 17.1%,” said the analyst. 

On dividends, HLIB expects the group to stick to its dividend policy of paying out at least 25% of its net earnings yearly. This would imply a current yield of 2.7%/3%/3.9% for FY20F-FY22F.

“Downside risks to our forecast include a shortfall in meeting order book replenishment targets, intense competition from other players with similar business models, a weaker-than-expected economic environment dampening demand thereby causing margin erosion, and a continued downturn in the O&G sector,” said Low. 

At the time of writing, shares in Serba were one sen or 0.6% higher at RM1.69, bringing its market value to RM5.73 billion.