Salcon ... Sep11

Inet Research

1. 2QFY11 Results Highlight

- Salcon reported a disappointing 2QFY11 results that was affected by exceptional items and startup expenses.

- In 2QFY11, while turnover only declined by 7.4% to RM100.6m, net profit plunged by 97.1% to
RM5.2m. The disappointing results was due to the following reasons:

o 2QFY10 included an exceptional gain from disposal of property amounted to RM5.5m;

o EBIT from Construction division declined by 34.8% to RM1.0m in 2QFY11 due to lower margin of construction projects; and

o Concession division’s EBIT also dropped by 12.4% in 2QFY11 to RM5.0m due to start-up and procurement expenses of China’s Changzhou concession and unrealised foreign currency translation losses. This Changzhou Southeast Industrial WWTP with a capacity of 30 MLD was recently awarded to Salcon in Mar-11. By extrapolating the increase in administrative expenses in 2QFY11, the start-up expenses and unrealised forex loss combined could amount to RM4.1m in 2QFY11.

1HFY11 Results Highlight
- For 1HFY11, while turnover was only marginally lower by 4.8% at RM211.0m, net profit declined sharply by 74.8% to RM4.7m.

- This was mainly attributed to the absence of exceptional gain of RM5.5m which was included in 2QFY10, the start-up and procurement expenses of China’s Changzhou concession and unrealised
foreign currency translation losses.


2. Earnings Outlook
- Annualised net profit for 1HFY11 is significantly below our earnings forecast for FY11. We are still of
the view that earnings performance will be better in 2HFY11 as well as FY12 due to more meaningful
contribution from its China concessions and absence of those exceptional items. Nonetheless, we have
reduced our earnings forecast by 16% for FY11 to account for the lower margin of construction projects
and higher administrative expenses.

- Salcon’s current profit base especially its China concession has yet to reach its full potential as the largercapacityconcessions such as Changle new WTP (100MLD), Changle Raw Water (100MLD) and Nan
An Raw Water (175MLD) will only be commissioned towards the later part of FY11. 2HFY11 should
also see more meaningful contribution from Haining WTP (300MLD) which was commissioned in
4QFY10.

3. Valuation and Recommendation
- For FY11, its earnings base is depressed by exceptional items and costs associated to progressive commissioning of its larger-capacity concessions. However, we are maintaining our Buy recommendation on Salcon for the earnings growth in FY12-FY13 arising from the doubling in production capacity towards the latter part of FY11.

- The stock is currently trading at 37% discount to its book value of RM0.75/share. The slide in its share price is not warranted as it does not reflect the promising long-term prospects of its growing concessionbased
business in China and the doubling in design capacity of its China concession by end-FY11.