APB Resources

This stock, APB Resources, is famously named as Baby KNM by RHB Research.

Well, this is one stock whose stock price has appreciated tremendously in recent months due to fact that it was in JV with PSCI. For me, this was the catalyst for its strong share price appreciation in recent months.

RHB today has another report on it today and one of the points worth noting is the fact that this JV has not been concluded YET.

Ah.. a risk? Maybe? For me, I think it would be rather foolish to discount this risk. No?

Anyway, here is what RHB is saying on this stock.

♦ PSCI jv discussions may be shaky. The company is currently still in negotiations with Boustead on the terms and conditions for the 50-50 joint venture to fabricate process equipment on 10 acres of sea-frontage land within PSCI’s 43-acre shipyard in Penang. Although management had previously expected to sign the agreement in 2QFY07 and commence operation towards the end of FY07, we believe discussions have been moving too slowly and may now be shaky. Management has set a deadline for middle of March to conclude the agreement or negotiations will likely be called off.

♦ Alternative plans. The company is currently evaluating two other proposals.

Firstly, management is looking at a piece of land of more than 10 acres with workable access to the sea to allow fabrication of more bulky process equipment.

Sea frontage would also allow loading and unloading of raw materials and products, which would improve the overall efficiency of the operation. Currently neither of APB’s yards (in Subang and Kuantan) have direct access to the sea, and all materials have to be transported by road. The second alternative would be to buy 18 acres of land near its existing Kuantan yard. The land may cost some RM5-6m and equipment and building would require capex of around RM20-25m over two years.

♦ Opportunity cost. Management readily admitted that the delay in the PSCI jv has resulted in lost opportunities. However, the company does not plan to rush into alternatives. Growth in FY07 will likely come from higher-margin product mix and recovery from the FY06 cost overruns.

♦ Normal capex of RM10m p.a. Management guided that the company will spend around RM10m p.a. in normal capex which can be easily funded internally from operating cashflow of RM19-23m p.a. in FY07-09. However, management is prepared to borrow to expand its capacity if the company opts to buy the land in Kuantan. Our sensitivity analysis suggests net debt/equity would still remain manageable at around 25%, vs 2% currently estimated for FY07.

♦ Good visibility. Management believes the earnings visibility is good for the next three years given confirmed major oil & gas, power and oleochemical projects, especially in Indonesia. Currently 90% of its sales are derived from overseas contracts, of which 50% are from the Middle East, 35% from Asia and 15% from Europe, US and Africa.

♦ New risk-management policies. The company has introduced new policies for dealing with contracts that require more exotic steel alloys to mitigate the risk of future cost overruns, including: 1) completion period increased from nine months to 15 months; 2) contract period to start only when the raw material is delivered; and 3) the client supplies the raw material. Management stated that the company is prepared to walk away from contracts where the client is not agreeable to these terms to prevent the recurrence of major cost overruns.

♦ Maintain Outperform. Although the failure to conclude the PSCI jv would be a disappointment and cause a further delay in APB’s capacity expansion plans, we note that our forecasts have not factored in the jv. We highlight that although we only expect 6% growth in turnover in FY07, we have forecast 18% growth in fully-diluted EPS, due to recovery from FY06 cost overruns and slight improvement in gross margins to 19%, from 18% in FY06 (adjusted for costoverruns).

The sector weighted average PER for CY07 has risen from 15x to 17x over the last three months. Maintaining a 25% discount to peers, to factor in APB’s relatively small market cap and tight liquidity, we have used a CY07 PER of 12.8x to derive our fair value of RM1.89/share. This implies a further 17% upside in the share price. Given the sustained momentum in the industry, good visibility ahead, and potential upside from future capacity expansion (via PSCI or otherwise), we thus maintain our Outperform call on the stock.