Tat Hong Holdings

Kim Eng on 2 Jul 2012

Initiate with BUY and target price of SGD1.41. We initiate coverage on Tat Hong Holdings with a BUY recommendation and target price of SGD1.41, pegged at 14x FY3/13F PER. We like Tat Hong for its predominant position in the local crane rental industry as well as wide reach overseas. While improving operating statistics clearly signal that the group is recovering from its trough, its China business also appears poised for a turnaround. We thus expect net profit to grow at 28.4% CAGR over the next three years.

More stable business model. As Tat Hong’s rental business, which enjoys more stable demand, begins to make up a bigger chunk of its total gross profit, earnings volatility should ease in tandem. A less volatile and cyclical business model will justify a higher valuation for the share price, in our view.

Tapping the infrastructure boom. A decade of economic growth in Asia has put a huge strain on the infrastructure of many countries in the region. However, government bailouts around the world in response to the global financial crisis have led to a massive increase in public works spending, boosting demand for infrastructure construction. Tat Hong stands to benefit from this infrastructure boom in the medium term.

Recovery from trough. Over the past four quarters, Tat Hong’s key operating statistics, ie, fleet size, utilisation and rental rates, have shown significant improvement. The trend looks set to continue for the next 2-3 years, buoyed by high demand in the region. We expect Tat Hong’s net profit to double from SGD42.2m currently by FY3/15F.

Turnaround in China business. Tat Hong set up operations in China in 2009 but it was plagued by local shareholder issues and did not contribute to the group’s previous earnings peak in FY3/08. However, as the shareholder issues get resolved and China steps up its infrastructure development efforts, we expect Tat Hong’s China business to turn around and help push earnings to a new peak.

More stable business model. Tat Hong used to grapple with lumpy earnings due to the cyclical nature of its equipment sales business. But we expect this situation to ease in the future as its crane and other equipment rental business, which enjoys more stable demand, makes up a bigger chunk of the group’s total gross profit.
Tapping Asia’s infrastructure spending boom. A decade of strong economic growth in Asia has put a huge strain on the infrastructure of many countries in the region. Governments have been galvanised into action upon realising that a lack of coordinated infrastructure investment would stifle growth and hurt the economy. Add to this the wave of government bailouts around the world in response to the global financial crisis and there have been a massive increase in public works spending, boosting demand for infrastructure construction. Recent natural disasters in Australia and other parts of Asia mean additional demand from recovery construction. In our view, Tat Hong stands to benefit from this infrastructure boom in the medium term.

Recovery from trough with brighter prospects ahead. Over the past four quarters, Tat Hong’s key operating statistics, ie, fleet size, utilisation and rental rates, have shown significant improvement. The trend looks set to continue for the next 2-3 years, buoyed by high demand in the region. We therefore believe that it would not be long before Tat Hong’s earnings hit a new high again.

Turnaround in China business. We expect Tat Hong’s China business to turn around within the next two years now that its local shareholder issues have been largely resolved. Demand would continue to be fuelled by Beijing’s enormous infrastructure spending, while intensive new capital investment may not be needed as the relatively low utilisation rate in China currently would provide sufficient capacity. The much-talked about property bubble is also no cause for concern because Tat Hong only has projects in the energy and transport sectors in China; the real estate sector has never been its cup of tea. Against this backdrop, we expect gross profit growth of 38% in FY3/13F and 31% in FY3/14F.

Initiate coverage with BUY and target price of SGD1.41. We initiate coverage on Tat Hong with a BUY recommendation and target price of SGD1.41. Our valuation methodology is premised on the PE multiple, which we set at FY3/13F 14x. We have also conducted a replacement cost analysis and found that despite a 12.5% YTD increase in Tat Hong’s share price, there is still at least 33% uncovered value. Put simply, at the current price, investors are buying Tat Hong’s physical assets at a 33% discount while enjoying for free all the other intangibles such as its client relationship, reputation and distribution network.