This article first appeared in The Edge Financial Daily on June 23, 2017

Dagang NeXchange Bhd
(June 22, 58.5 sen)
Initiate add with a target price (TP) of 72 sen: Dagang NeXchange Bhd (DNeX) is a proxy for the government’s plan to roll out vehicle entry permit and road charges (VEP and RCs) at Malaysian borders, in our view.

The group diversified into energy by acquiring OGPC and Ping Petroleum Ltd in 2016.

We project financial year 2016 (FY16) to FY19 earnings per share (EPS) compound annual growth rate (CAGR) at 16%, driven by VEP and RCs at the Malaysia-Thailand border, as well as stronger earnings from OGPC and Ping Petroleum on the back of higher crude oil prices.

DNeX had a net cash position and healthy free cash flow as at end-March 2017.

We initiate coverage of DNeX with an “add” rating and sum-of-parts-based TP of 72 sen. DNeX is the exclusive operator of the National Single Window (NSW) platform, which provides trade facilitation services to the Royal Malaysian Customs Department.

We expect NSW to remain a key earnings driver, fuelled by rising transaction volume from the business-to-business (B2B) segment. Although the government’s transaction volume is expected to drop following the expiry of the platform’s exclusivity in the fourth quarter of 2018 (4Q18), DNeX expects to retain its B2B segment transaction volume due to an increase in platform stickiness driven by new value-added services.

The key facilitator of VEP and RC project implementation in 2016 and January 2017, DNeX was awarded two contracts worth RM149.3 million to develop, install and maintain the VEP and RC system and equipment for five years at the Malaysia-Singapore border in Johor.

We believe DNeX stands to benefit from the government’s plan to roll out similar projects at the remaining 15 crossing points into Malaysia. We expect the Malaysia-Thailand border VEP and RC contract to begin in 2018. Overall, we project VEP and RC services to contribute 12% to 16% of the group’s FY17 to FY18 pre-tax profit.

DNeX embarked on a new oil and gas (O&G) venture by completing the acquisition of OGPC for RM170 million in 2Q16. The group expects stronger profit contribution from OGPC in FY17 to FY18, driven by a pickup in O&G activities following higher average crude oil prices and potential new contract awards.

In addition, DNeX was the only local service provider awarded a three-year drilling and services contract by Petronas Carigali in 2016.

In 2Q16, DNeX also invested US$10 million to acquire a 30% stake in Ping Petroleum, an upstream O&G service provider with a 50% stake in the Anasuria cluster in the North Sea. The investment amount implies low entry cost of below US$2 (RM8.58) per barrel (historical average for comparable transactions).

The group projects RM22 million to RM25 million associate profit contribution from Ping Petroleum in FY17 to FY18, based on a US$50 crude oil price per barrel. We expect DNeX to record a robust FY16 to FY19 net profit CAGR of 16%, driven by resilient earnings growth in the IT services and energy segments. However, we expect the energy division to record a faster growth of about 19% per annum, driven by new contracts (versus a 13% growth for the IT division).

Hence, we expect net profit contribution from the energy division to grow from 52% in FY16 to 58% in FY19. Our TP is based on 16 times FY18 price-earnings ratio, above its historical five-year mean of 15 times, but it is still attractive, given our strong FY16 to FY19 EPS CAGR projection of 16%.

VEP and RC contract awards and higher crude oil prices are potential rerating catalysts.

Key downside risks include lower crude oil prices, a decline in NSW transaction volume post-expiry, and delays in VEP and RC contract awards. — CIMB Research, June 22