Tat Hong Holdings Ltd: Holding out for inorganic growth

1Q10 performance fell short of expectations. Tat Hong Holdings Ltd's (Tat Hong) 1Q10 results came in below expectations. Revenue slipped 37.2% YoY to S$120.1m and net profit tumbled 63.9% to S$10.6m. Stripping away the impact of non-core items such as forex, core net profit would have fallen by a larger 67.4% to S$8.2m. Sequentially, sales improved by 8.5% but core net profit decreased by 58.6%. No dividends are declared for 1Q. Broad-based revenue decline, with the exception of Tower Crane.

With the exception of the Tower Crane division, all other segments posted weaker revenue. Equipment Sales recorded the steepest fall (-60% YoY) as customers reigned in on capital expenditure in light of the economic crisis. Crane Rental, on the other hand, remained relatively stable with revenue contracting by just 2%. We expect stable rental income to partially offset the steep decline in equipment sales in FY10.
Profit margins contracted. While we had anticipated weaker revenue, the sharp drop in 1Q10 earnings came as a surprise. Although gross profit margin improved by 2.6ppt to 39.4%, operating expenses did not fall as significantly as revenue, and this resulted in a 4.6ppt drop in EBIT margin to 17.1%. Poor results from associates further dragged down its bottom line, with net profit margin contracting by 6.5ppt to 8.8%.

Holding out for inorganic growth. Management continued to paint a cautious outlook for FY10 as weak equipment sales are expected to dull the group's performance. On the bright side, economic stimulus plans may support its rental income. In our view, the environment for organic growth remains highly challenging in the near term. Tat Hong's next phase of growth is more likely to be driven by inorganic growth. Following AIF Capital's recent S$65m strategic investment, Tat Hong is equipped with the financial flexibility to expand via M&As or JVs. In addition, AIF Capital could introduce new growth opportunities that were previously unavailable to the group.

Maintain HOLD. We have cut our FY10 earnings forecast by 20% following Tat Hong's poor 1Q10 showing, bringing our fair value estimate slightly lower to S$1.13 (previously S$1.15). While we note the risk of continued near term earnings pressure, we maintain our HOLD rating on the stock given the enhanced likelihood of inorganic growth following the emergence of a strategic investor, coupled with a relatively decent 3.6% dividend yield.

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