This article first appeared in The Edge Financial Daily, on September 25, 2015.

Unimech Group Bhd
(Sept 23, RM1.31)
Maintain sell with an unchanged target price (TP) of RM1.15: Management remains “cautiously optimistic” about its outlook amid the various challenges posed by the slowing economy and weak currency. The sharp decline in crude oil price and the escalating margin pressure due to the weak ringgit versus the US dollar are near-term earnings risks.

The share price declined 20.2% for the past one year. At this juncture, we do not see any rerating catalyst for the stock and therefore, we are maintaining our “sell” recommendation on Unimech, with an unchanged TP of RM1.15, based on TP earnings ratio of 10 times.

Unimech’s earnings before interest and taxes margin narrowed by 3.3 percentage points year-on-year (y-o-y) in the first half of financial year 2015 (1HFY15). In a meeting with management recently, we understand that margin volatility is caused by a weaker ringgit, which makes the cost of unhedged raw materials to go up.

Year to date, the ringgit has declined by more than 20% against the greenback. The procurement of raw materials is mostly transacted in US dollars or the yuan, also pegged to the US dollar, but management declined to share the percentage of cost that is exposed to foreign currencies.

However, we understand that management is considering price hikes for its products to protect the margin, going forward. On a positive note, management reckons that higher prices would render the group uncompetitive, given that the currency pressure is being felt across the industry.

Indonesia remains the group’s largest overseas revenue contributor. The economic slowdown in Indonesia saw PT Arita’s 1HFY15 net profit declining by 68.2% y-o-y in 1HFY15. Nonetheless, management has no intention to pare down Unimech’s 70% stake in the listed company.

We agree that the long-term upside risk to growth in Indonesia outweighs the short-term slowdown. Moreover, the Indonesian government has in recent weeks announced measures to open up the economy and boost infrastructure spending.

Domestically, management guided that capital expenditure (capex) will remain low for FY15 through FY17. Capex is projected to amount to RM10 million per annum, compared with RM26.9 million in FY14. This reflects the prevailing market conditions.

With the capex cut back, we believe the group will be able to meet the internal dividend target of 30% of net profit per annum. In the past few financial years, the group has invested aggressively in warehousing capacity, principally to expand product range and optimise the delivery time.

However, in FY13 and FY14, the growth in inventories had been tapering off. As a result, the working capital deficit has been narrowing and therefore, giving room to maintain the dividend payout.

Our FY15 net profit estimate of RM16.9 million implies 12.9% growth y-o-y. This suggests earnings picking up in 2HFY15. We understand that there are several projects the group are bidding for. If it is successful, it will boost earnings ahead.

However, we maintain our “sell” recommendation on the stock underpinned by the weak demand in the oil & gas (O&G), and plantation sectors.

We believe the stock is fairly valued at unchanged TP of RM1.15 per share, based on 10 times calendar year 2016 diluted earnings per share of 11.5 sen.

Two potential catalysts for the stock are capex upcycle resuming in the O&G and plantation sectors, as well as a recovery in exchange rate. — TA Securities, Sept 23