This article first appeared in The Edge Malaysia Weekly on November 13, 2017 - November 19, 2017

SEEING Sarawak Cable Bhd’s high gearing and falling profitability, institutional investors have fled the stock. As a result, the company’s share price has languished, drifting to 99 sen last Thursday — the lowest closing since May 2013.

The management is aware of the company’s problems and is working to tackle them in the next six months. If successful, it could mean a turnaround for the company. The only catch is, things will have to get worse before they can get better.

“It is going to be a kitchen-sinking year,” group managing director and CEO Aaron Toh tells The Edge.

“There is going to be some restructuring to reduce costs, and we are also looking to dispose of our helicopter services business. If I can, I’d sort this out by the end of the year and clean up our books.”

At first glance, Sarawak Cable’s financials look troubling. The group’s revenue fall 26% year on year to RM527.5 million for the six months ended June 30. Net profit declined by a similar quantum — down 27.4% y-o-y to RM6.18 million. To make matters worse, the group had a staggering net debt of RM628.8 million and a net gearing of 193%.

It is not surprising that fund managers shun the stock. With the current figures, it sure looks like a major challenge to turn the company around.

However, Toh speaks confidently about the company’s prospects going forward.

For starters, he points out that its core cable manufacturing business is still doing quite well. For its six months ended June 30, the division registered an 18.4% y-o-y increase in revenue to RM441.14 million. Pre-tax profit for the division grew 6.8% y-o-y to RM28.03 million.

So, why did the group perform so poorly?

The shortfall in revenue came mainly from the segment that constructs transmission lines; it saw an 80% y-o-y plunge in revenue to RM60.8 million. As a result, the segment went from contributing a pre-tax profit of RM13.2 million last year to incurring a pre-tax loss of RM4.75 million this year.

The group’s profits were also dragged down by its helicopter services arm.

“We provide helicopter services for the oil and gas industry. As that industry has slowed down, so has our business. Not only are our helicopter assets underutilised but we are also servicing the debt related to it,” explains Toh.

The power generation, helicopter services and corporate segment posted a loss of RM10.95 million on revenue of RM8.89 million in the first half of the year.

On top of that, the division is carrying a debt of about RM200 million — roughly half of which involves advances from the parent company.

Thus, disposing of the helicopter unit is one of the group’s top priorities, says Toh, noting that Sarawak Cable is already in talks with potential buyers.

In total, the company has nine helicopters and one simulator. “The fleet includes an Eurocopter EC225 Super Puma, which costs about RM100 million,” says Toh.

Unfortunately, the sale of the helicopter business is likely to incur impairments. Toh says he expects to divest the business at a 20% to 30% discount due to the soft market conditions.

That means selling the business and the accompanying debt for RM50 million to RM60 million. This is not ideal, but it will result in immediate savings for the group.

“We estimate it will save us RM20 million a year — RM10 million in interest cost and RM10 million in operating cost,” says Toh.

Against this backdrop, he says the company will also be restructuring its transmission line construction arm to reduce costs. He acknowledges that the amount of new transmission line work to be carried out in the country is on the decline. This is due in part to an expected slowdown in new power plant projects.

On top of that, he says, the margins for the business are becoming more and more compressed with competitors undercutting pricing by more than 30%.

Rail catalysts for cable making

The good news is that Sarawak Cable is still one of the major suppliers for transmission line cables in the country. Even if it fails to secure contracts for the construction of new transmission lines, it will still make money selling cables.

For its trailing 12 months ended June 30, Sarawak Cable netted RM49.8 million from the sale of power and telecommunication cables. So, if it can hive off its loss-making units and resize its construction arm properly, the company could be in a good position next year.

“Tenaga Nasional Bhd (TNB) has over 30,000km of transmission and distribution lines. Every year, it allocates RM1 billion for the replacement of old cables. This is our bread and butter,” explains Toh.

In fact, there may be several rerating catalysts for the industry.

First, it will be the base tariff revision by TNB at the beginning of next year. This will ensure that the utility company makes enough money to spend on capital expenditure. Of course, some of these funds will go to maintenance and replacement of transmission lines.

If TNB increases its allocation for the replacement of old transmission lines, this could give Sarawak Cable a boost.

Another potential catalyst is the slew of rail projects in the pipeline — the second and third mass rapid transit lines (52.2km and 45km long respectively), the East Coast Rail Line (600km), the Kuala Lumpur-Singapore high-speed rail (350km) and the Gemas-Johor Baru double-tracking and electrification project (190km).

In total, that is easily more than 1,200km of track that needs to be laid and all of it will be electrified. This means that underground cables will be needed, something that Sarawak Cable will certainly benefit from it.

While Toh is unable to give estimates on the potential value of the projects to the company, he expects 275kV underground cables to have better margins.

Power and telecommunications as well

Apart from its core business, Sarawak Cable also has a mini-hydro venture in Sumatra, Indonesia.

“The project has been delayed by almost two years due to various local factors. But now, we are close to completing it. We aim to begin generation by the end of the first quarter of next year,” says Toh.

He estimates that the 8mw plant will be able to generate RM20 million in earnings before interest, taxes, depreciation and amortisation a year due to favourable tariffs.

Another catalyst that Sarawak Cable is looking at is the construction of telecommunication towers in Sabah and Sarawak. Recall that Budget 2018 allocated RM1 billion for the Malaysian Communications and Multimedia Commission to “develop communication infrastructure and broadband facilities in Sabah and Sarawak”.

“The state (Sarawak) is also allocating RM500 million for telecommunication infrastructure. This will be funded by the Sarawak Development Bank,” says Toh.

Given Sarawak Cable’s ability to manufacture telecommunication cables and its construction arm’s capability in fabricating and installing telecommunication towers, he says the group will be an indirect beneficiary.

Recall that Cahya Mata Sarawak Bhd (CMS) has a 50% stake in Sarawak’s state-controlled telecommunication infrastructure arm, Sacofa Sdn Bhd. CMS, of course, is a sister company of Sarawak Cable — linked by their common shareholder and director, Datuk Seri Mahmud Abu Bekir Taib, the son of the Yang di-Pertua Negeri of Sarawak.

Apart from being a substantial shareholder in both companies, Mahmud Abu Bekir is the non-executive chairman of Sarawak Cable and the deputy group chairman of CMS.

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