This article first appeared in The Edge Malaysia Weekly, on January 16 - 22, 2017.

MUHIBBAH Engineering (M) Bhd and its 60%-owned unit Favelle Favco Bhd have started the year with a bang.

Last Tuesday, Muhibbah announced that it had secured a 356.7 million Qatari riyal (about RM438.1 million) contract to conduct road and infrastructure works at Um Alhoul Economic Zone in Qatar. Meanwhile, Favelle Favco won a RM64 million contract early this month and a RM70.6 million job in November last year.

These contracts have triggered interest in the companies’ shares, which have risen steadily in the past month. Muhibbah surged 11.34% to RM2.38 as at Jan 12 from its one-year low of RM2.11 on Nov 29 last year, while Favelle Favco has rebounded 13% from RM2.32 in Dec 20 last year.

Muhibbah co-founder and managing director Mac Ngan Boon tells The Edge that the group hopes to strengthen its presence in the Middle East by securing more infrastructure works this year.

“We are more careful when bidding nowadays to avoid a cost overrun. It is a lesson we have learnt. We are looking at jobs with more reasonable margins,” he says, adding that the jobs at Um Alhoul Economic Zone should offer better margins. He sees Qatar as a potential market in the longer term as the World Cup will take place there in 2022.

Including the latest contract win, Muhibbah’s outstanding order book stands at RM2.2 billion, which provides the group with earnings visibility for at least two years. It is also tendering for jobs worth up to RM5 billion — mainly infrastructure works, both locally and overseas.

“We are always looking for new markets, such as the Philippines, Indonesia and Myanmar. We are eyeing the infrastructure opportunities there, such as ports and airports, which are part of our expertise,” says Mac.

However, the group’s crane business is still a drag on its performance. Due to lower contributions from the division, net earnings for the third quarter ended Sept 30 last year (3QFY2016) were flat at RM22.56 million, compared with RM22.96 million in the previous corresponding period.

In contrast, supported by higher contribution from its construction division, Muhibbah’s net profit grew 11.6% to RM73.12 million for the nine months ended Sept 30 last year (9MFY2016).

The crane division, which is heavily dependent on the oil and gas industry, still needs some time to recover as upstream activities have yet to pick up, says Mac, who is also executive director of Favelle Favco.

“Oil prices may be up but investments going into the upstream business remain cautious. I think that the markets for oil and gas, even for manufacturing, are adopting a wait-and-see stance.”

He expects the group’s earnings to recover only next year, and business to improve at the end of this year when the oil and gas majors start to replenish their depleted fields.

Favelle Favco’s order book stands at RM650 million, which is lower than the RM936 million seen in FY2015. About 70% of the company’s orders come from its construction side.

In the short term, its earnings will mainly come from construction cranes. But Mac believes oil and gas cranes will be the group’s key driver in the long term.

“The US’ and Australia’s continued demand for construction cranes will be positive for us, and the move to renewable energy is also positive for us, but it is still hard to make up for the loss in the oil and gas sector,” he says.

Hit hard by the slowdown in the sector, Favelle Favco may fail to sustain the continuous annual growth it has seen since its financial year ended Dec 31, 2005 (FY2005), in FY2016.

Due to lower sales, the group’s net profit fell almost 26% to RM23.17 million in 3QFY2016. For 9MFY2016, net profit decreased 22.52% to RM54.44 million.

“The good thing is that we can still maintain positive numbers in times like these. We are quite active in trimming our operational cost. Hopefully, two to three years from now, we can catch the next wave,” says Mac.

Meanwhile, Favelle Favco, which is in a net cash position of RM304.2 million, is looking for a merger and acquisition target after three sessions of fruitless talks.

“These are crane, engineering and marine equipment companies in Europe and Australia. We gave up on these companies after looking deeper into their accounts. We saw things that we were not comfortable with,” Mac says, adding that it is not easy to find a good target.

Fund managers and analysts opine that the recent wins should lend support to the shares of Muhibbah and Favelle Favco as the contracts provide the companies with earnings visibility this year.

They say positive sentiment returning to the oil and gas sector after the rebound in oil prices could be another reason for the rise in the share prices. Brent crude oil prices have gained 24.24% to US$55.20 per barrel, from a five-month low of US$44.43 on Nov 14 last year.

Fund managers and analysts say the valuation of the two counters are attractive. However, they do not believe that Favelle Favco deserves a “buy” call. This is due to the absence of earnings growth, which may also affect the company’s dividend yield, which is 5.77% based on its last closing price.

“Favelle Favco has always been cheap as its earnings have been stable over the past couple of years. But we are still a bit cautious about its outlook as the company is involved in crane fabrication … newbuilds for vessels or platforms [in the oil and gas sector] might take a while to come in,” RHB Research analyst Wan Mohd Zahidi tells The Edge in an email.

He believes Favelle Favco’s earnings for the fourth quarter and the full year will be lower on a year-on-year basis as 2015 was a good year in terms of profits. “However, with the expected slowdown in crane orders, it is within expectations,” he adds.

Wan and a fund manager, who declined to be named, are of the view that Muhibbah is fairly cheap, supported by its order book. The company has not disappointed the investing community in terms of its order book replenishment due to its diversified portfolio and the stable recurring income from its concession business.

However, Muhibbah’s private placement could lead to an overhang in its share price in the near term, they say.

The group had proposed to undertake a private placement of 48.2 million shares to raise up to RM111.9 million for debt repayment and working capital purposes. But due to the weak market sentiment, the placement has been delayed until May 9.

According to Mac, the group will not call off the share placement exercise. It is waiting for the right time to implement it, he adds.

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