This article first appeared in The Edge Financial Daily, on March 9, 2016.

Coastal Contracts Bhd
(March 8, RM1.69)
Maintain market perform with an unchanged target price (TP) of RM1.76: We came away from Coastal Contracts Bhd’s (Coastal) fourth quarter of financial year 2016 (4QFY16) briefing feeling concerned over its FY17/18 estimate earnings outlook due to its depleting order book. Aware of the current challenging environment, the management is in talks to secure new projects, but within the same sector. While the nature of new business ventures was not disclosed, we believe this is a good move to diversify Coastal’s current concentrated risk in shipbuilding.

Having said that, the core business will continue to face margin pressure amid slower vessel sales. Balance sheet-wise, Coastal is still relatively healthy with a net cash position compared with industry peers having an average net gearing of 0.6 times. All in, we maintain a “market perform” call with a TP of RM1.76 pegged to calendar year 2016 (CY16) price-earnings ratio (PER) of eight times.

We are guided that Coastal is looking to take on new projects in the region such as Brunei. While the management is keeping its lips sealed on the nature of new contracts, which we believe will require a blend of Coastal’s core expertise and new skills, we have come to know that one of the projects is a regional one with a potential contract value of RM500 million, spanning over three to four years.

We also understand that this project requires collaboration from other parties and external funding to execute. No further details were disclosed as the deal is still at a preliminary stage and will only materialise earliest at the end of the year.

Its first jack-up gas compression service unit (JUGSU) to Petróleos Mexicanos SA is currently undergoing commissioning in Mexican waters, and looking to generate recurring income by the second half of CY16 (2HCY16), slightly slower than the initial expectation of 1HCY16.

There are no changes to our forecast as we have already factored in the delay into our forecast. The management is confident that it is in a good position to secure another gas unit project should this JUGSU be successfully operated.

Recall that Coastal has made an impairment loss on receivables of RM9 million and inventories write-downs amounting to RM56.7 million (more than 10% of stocks to build) in 3Q16.

Although the management assured that there will not be any further impairment in the next two quarters, we reckon that there is still impairment risk as we believe the market prices of vessels will fall further due to oversupply.

The management guided that the operating environment continues to be tough and net margin for vessel sale has dropped to a single digit to 9% in 4Q16 versus 22% in FY14. Meanwhile, Coastal has stopped building new vessels, and their focus is to let go all the vessels in hand, including RM500 million worth of build to stocks, to recoup cash even at a slight loss of 5% for selective type of vessels. Hence, expect further margin compression in the next few quarters.

Given the quiet offshore support vessel market amid the industry downturn and current order book of RM1.2 billion, likely to last till 1HCY17, we believe Coastal will encounter earnings weakness in FY18 due to slow pickup in vessel sales. Balance sheet-wise, Coastal is back to net cash position of RM34 million in 4Q16 from a minimal net gearing of 0.06 times in 3Q16, which is healthy versus industry average of 0.6 times.

All in, we feel that the near-term outlook remains sluggish, especially in FY18 when the remaining order book dries up. Rerating catalysts could emerge if Coastal manages to venture into new space and secure sizeable regional projects. We maintain a “market perform” call at a TP of RM1.76 pegged to a CY16 PER of eight times. — Kenanga Research, March 8