PEC Ltd

OCBC on 17 Sept 2012

PEC Ltd’s (PEC) share price has fallen by almost half from its peak of S$1.37 per share in Jan 2011 and may have already bottomed out. We now see very deep value in the group, with its stock trading at 13% discount to its book value of S$0.79 per share with a net cash of S$0.44 per share or 64% of its market capitalization. Excluding its net cash value, it is trading at just 3x PER. Meanwhile, our channel checks inform us that the current pricing levels are too tight for the downstream EPC subcontractors to bear, and are unsustainable in the long run. We agree and therefore believe that a margin reversion may be possible in the near- to medium- term horizon. Upgrade to BUY with a higher fair value estimate of S$0.86 (previously S$0.64).

Deep value
PEC Ltd’s (PEC) share price has fallen by almost half from its peak of S$1.37 per share in Jan 2011 and may have already bottomed out. Year-to-date, its share price has also been uninspiring, hovering mostly around the S$0.60-S$0.70 region. We now see very deep value in the group, with its stock trading at 13% discount to its book value of S$0.79 per share with a net cash of S$0.44 per share, or 64% of its market capitalization. Excluding its net cash value, it is trading at just 3x PER.

Rotterdam issues over
Previously, investors were concerned about PEC’s cost over-run issues at its Rotterdam JV project. With its S$17.3m allowance for its debt against the JV company – Verwater-Audex B.V. in 4Q12, PEC has finally reached a closure on the issue. We do not expect further write-offs. Looking ahead, we believe the management will focus its energies on growing its business in the Middle East and Southeast Asia regions.

Possible margin reversion
Recall that PEC’s gross margin fell to 19% in FY12 from 28% a year ago, mainly due to stiffer pricing competition in the industry. Our channel checks inform us that the current pricing levels are too tight for the downstream EPC subcontractors to bear, and are unsustainable in the long run. We therefore believe that a margin reversion may be possible in the near- to medium- term horizon. After all, oil refineries need sub-contractors to service their plants and therefore it is in their best interests to see that its subcontractors are earning healthy level of margins.

Upgrade to BUY; FV raised to S$0.86
We see deep value for PEC and believe that margin reversion is possible. Therefore, we raised our fair value estimate to S$0.86 (previously S$0.64) on 1x (previously 0.8x) P/B. Upgrade to BUY.