26 March 2012

EP Manufacturing Bhd (EPMB) may have taken the highway to depressing its valuation but the Maju Expressway Sdn Bhd (MESB) buyout could prove a worthy deal in the next five years.

When the deal was first made public, analysts downgraded the counter to either a “sell” or “neutral” call as they tried to grasp EPMB’s rationale for buying into the operator and concessionaire of Maju Expressway (MEX) and its debts for a total consideration of RM1.7bil.

EPMB’s executive chairman Hamidon Abdullah said that the acquisition was in line with the company’s portfolio expansion and was complementary to its automotive business.

In the media conference announcing the deal on March 16, Hamidon said that MEX was expected to generate over RM70mil revenue for the current financial year.

“This investment in MEX is expected to generate equity returns of 17%, and we are looking at some dividend flows coming from MEX in the medium term,” he said.

However, an analyst highlighted that EPMB is paying the full price for MESB. “This is in contrast with former parent company Maju Group which had received government grants worth RM976.7mil to build the MEX project that cost RM1.32bil,” the analyst said.

EPMB’s share price tumbled 25% from RM1.12 before the deal was revealed to close at 84 sen last Friday.

Although EPMB will likely remain unappealing to some investors following depressed overall margins due to high interest and depreciation costs, analysts cannot deny that the purchase of MEX could reel in hefty rewards for EPMB when the toll concession matures and begins to give sustainable profit in the coming years.

Last Thursday, the management told analysts that MEX could be loss-making until 2016 but it was confident that EPMB could cope with the record high net gearing incurred. Under the acquisition, the auto parts maker’s net gearing will rise from 33% a year ago to 435%.

Analysts did not revise their downgrade on the counter after the briefing.

Financing of the gearing would come through free cashflow from a likely toll hike in 2013, coupled with expected traffic growth courtesy of Putrajaya and Cyberjaya developments and the completion of klia2.

MEX’s toll concession has a remaining period of more than 25 years.

OSK Research was slightly more optimistic, projecting EPMB’s first profit from the acquisition to be realised in 2014 with a net income of RM7.2mil out of the total projected net profit of RM32.4mil.

For now, OSK Research has trimmed EPMB’s earnings for financial years 2012 to 2014 sharply by 45% to 58%.

OSK analyst Ahmad Maghfur Osman added that as the toll matured in 10 to 15 years, the free cashflow generated would exceed RM250mil annually compared to a projected RM45mil for the financial year 2013.

The buyout then serves EPMB’s motive to diversify its income stream. EPMB already has a water concession in Indonesia and had also expressed interest in real estate development, road construction and more infrastructure jobs.

However, this drastic diversification had analysts bearish on EPMB’s short term valuation. OSK Research believes that the toll concession would draw bond investors more with its attractive yields.

“From an equity investor’s point of view, the acquisition does not fit in well with EPMB’s overall core automotive business and would make the stock an unappreciated counter once more (like when EPMB first sealed its water concession in Indonesia),” Ahmad wrote in his report.

Another analyst said that from both auto parts makers EPMB and Delloyd Venture Bhd’s diversification moves, automakers seem to crave revenue stability.

“Auto parts manufacturing is very cyclical. It depends heavily on sales and that in turn depends on the economy,” he said, “It appears that they want something with more stable recurring profit but they would have to compromise on a lower return on equity.”

He said that while EPMB will eventually gain sustainable profit from the deal, it would take a lot of time to stir investors’ interest at the in the near term.

In reflection, he noted that Delloyd has been able to grow its plantation business while maintaining its core business.

He believed that the best way for EPMB to improve its valuation is through spinning MESB on a separate listing in due time.

EPMB will settle the acquisition through the issuance of 38.462 million new shares worth RM50mil, 100 million redeemable unsecured loan stock worth RM100mil as well as RM1bil cash.

Under the deal, EPMB will also redeem MESB’s Islamic medium-term notes worth a nominal RM550mil.

Consequently, its share capital will rise from RM165.9mil to RM204.4mil.

In terms of new shareholding, MESB’s former owners Bright Focus Sdn Bhd and Ulimas Sdn Bhd will have 18.2% and 0.6% blocks while Maju Group executive chairman Tan Sri Abu Sahid Mohamed will have an 18% stake in EPMB.

The company maintains that auto parts manufacturing will continue to be its core business as it made up 97% of its revenue stream while the Indonesian water concession contributed 3%.

EPMB is a tier-1 vendor to the country’s two notable national car manufacturers Proton and Perodua which form 87% of their customer base.

Of EPMB’s consolidated performance, automotive had contributed RM559.136mil revenue while the water concession gave RM17.996mil.

In its financial year ended Dec 31, 2011, the company had raked in a net profit of RM38.077mil compared to RM26.106mil a year ago.

Its last quarter results did better as well with RM8.258mil net profit against RM8.161mil in the previous corresponding quarter.

Source: biz.thestar.com.my

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