This article first appeared in The Edge Financial Daily on March 6, 2020

Serba Dinamik Holdings Bhd
(March 5, RM2.25)
Maintain a buy with a diluted target price of RM2.65: Serba Dinamik Holdings Bhd’s order book increased to RM10.7 billion as of Feb 20, split between operations and maintenance (O&M) — RM7.1 billion and engineering, procurement, construction and commissioning (EPCC) — RM3.6 billion. Based on revenue of RM900 million for EPCC works in 2020, we continue to assume Serba needs to win RM5 billion-RM6 billion in new contracts (2019: RM3.5 billion) to meet its ambitious order book target (50% year-on-year [y-o-y] growth). Our assumption, along with its past announced contract wins, inherently assumed O&M contract renewals. If none of the O&M contracts are renewed, Serba will require RM10 billion-RM11 billion of new contracts (based on our 2020F [forecast] revenue) to reach its target.

In 2019, the group’s IT revenue grew strongly to RM100 million (from a negligible base). Aside from artificial intelligence and smart maintenance businesses to complement its O&M, and the associate sales and profitability (SAP) business eNoah, the SAP IT segment has few major applications being commercialised, such as  QwikPay, MyTPA, gceXchange, and two new apps namely nidcert (a blockchain application) and EasyBuyBye (e-commerce platform).

Serba recently redeemed its local sukuk but raised RM2 billion in new debt to fund existing and incoming growth projects (for example, the highly anticipated new Pengerang EPCC contract). The sukuk redemption effectively eases the stricter gross gearing ratios set by local rating agencies, and now we understand the current restriction is a maximum net debt/earnings before interest, taxes, depreciation and amortisation (Ebitda) of 2.5 times. This compares with the net debt/Ebitda of 1.6 times and 2.3 times in 2018 and 2019 respectively. While our forecasts have not yet factor in further equity raising, we do expect this needs to happen in 2020 or the ratio will be breached.

For 2021, revenue is premised on a higher order book of RM13.5 billion (RM11 billion previously). We continue to be conservative relative to Serba’s RM15 billion order book target. All these are offset by a much higher borrowing base and our finance cost assumption is adjusted to >RM0.23 billion per year. Our 2020-2021 net profit y-o-y growth of 24% and 21% (2019: 36%) will correlate with its order book growth, even though they are above the management’s conservative growth guidance.

Risks include cancellation or non-renewal of contracts, geopolitical risks, uncontrollable joint-venture losses, the US dollar-ringgit exchange rate and Serba requiring significant working capital (inventories and receivables) to grow revenue. We expect negative free cash flow (FCF) in 2019-20 on capital expenditure expansion. This is in line with the management’s FCF guidance and its intention for sukuk raising. Its gross gearing has a comfortable limit of 1.25 times — UOB Kay Hian, March 3