This article first appeared in The Edge Financial Daily on December 5, 2019
Favelle Favco Bhd
(Dec 4, RM2.88)
Initiate buy with a target price (TP) of RM3.65: Favelle Favco Bhd is a cash dynamo and is financially resilient in a capital expenditure-heavy, cyclical-driven oil and gas (O&G) industry.
Its cranes manufacturing and automation businesses are asset-light and cash-generative. Favelle is net cash and has consistently paid dividends, atypical in this industry.
Favelle offers earnings growth (three-year net profit compound annual growth rate [CAGR] of 13%), high dividend yields (5% to 6%) and undemanding valuations (seven times price-earnings ratio [PER]) versus peers. Accretive merger and acquisition, akin to the acquisition of Exact in 2018, would add to upside.
Prospects are bright for Favelle to capitalise on the global O&G offshore investment upcycle via its cranes construction/ maintenance/rental and automation businesses. Eighty per cent of its cranes manufacturing revenue is O&G-related.
Order book visibility is improving; up 32% year-on-year end-November (to RM564 million) after having bottomed out in 2018.
We expect Favelle to grow its order backlog to RM600 million to RM800 million in the financial year ending Dec 31, 2019 (FY19) to FY21, a realistic target (2014 peak: RM1.1 billion) that underpins three-year 13% net profit CAGR (FY18 to FY21).
A remarkable feature of Favelle is that it has always been running on a profit, even during the down cycle (2014 to 2017), which is a testament to its cost-focused and bottom line-driven management.
It has been net cash since 2010 and has consistently generated positive free cash flow (FCF). We estimate FCF of RM39 million to RM84 million in FY19 to FY21, equivalent to FCF yields of 6% to 14%, a strong foundation for consistent dividend payouts. At a 40% dividend policy rate, this translates into an attractive dividend yield of 5% to 6%.
Our TP is based on 0.6 times enterprise value/order backlog of RM725 million, pegged at one standard deviation above its five-year mean valuation.
The orders are premised on its average revenue for FY20 to FY21. We prefer this valuation method over others for it captures the cyclical nature of its order book and takes into account its balance sheet and cash flow aspects.
Our TP, which implies 9.7 times PER and 4.1% dividend yield for FY20, is undemanding vis-a-vis its peers. — Maybank IB Research, Dec 3