Loxley - OSK

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RHB Research 06 Mar 2013 KEY INVESTMENT RISKS Execution risks. Loxley, as a leading ICT player, will benefit from the massive investments being pumped into the sector in Thailand as well as the region. While there are no concerns over its ability to grow its backlog, its ability to turn its new backlog into earnings remains rather questionable judging from its past track record. The historical gross profit margin for the company had been decent at around 15%-18%. However, high selling and administrative expenses have dragged down profitability. The same can also be said about its trading and services segments. As such, we believe that the concerns over the company’s execution risks are rather valid. Uncertainties over the online lottery project. The online lottery project was part of former prime minister Thaksin Shinawatra’s policy to clamp down black market lotteries, legalizing it while generating additional revenue for the government. Loxley’s JV company, LGT, was given the award to roll out the installation of the online lottery back in 2006. Due political turmoil, the implementation of online lottery has been delayed indefinitely. So far, LGT has invested around THB1.5bn, with 6000 machines installed nationwide. While the current government plans to proceed with the roll out of the online lottery, there are still uncertainties over the actual execution given the politically-sensitive nature of the issue. While the company has set aside some provisions in the event that the project gets scrapped, we think there is always a possibility that the provisions are insufficient and it may need to inject additional funds into the investment. Even so, the negative news flow in regard to the potential cancellation of the project will result in pessimistic sentiment on the stock price. Political risks. Given that most of Loxley’s ICT contracts are from the government and government agencies, the contracts flows are highly dependent on the political stability whereby any change in political leadership could hamper the progress in awarding these contracts. As such, we think Loxley’s high dependency on government-related contracts expose the company to political risks, and under a less-than-ideal situation, it might not being able to replenish its backlog due to the delay in the implementation of government projects. Heavy balance sheet and earnings dilution. Due to the company’s high borrowings, it incurred a rather significant finance cost amounting to over THB230m in FY12. While its operating gross profit margin was rather healthy and comparable to its peers, its high finance costs have been eating into its bottomline over the last few years. We believe its highly-geared balance sheet leaves the company limited room to gear up further, in the event it needs to raise capital. While the proposed PO could provide additional capital for the company without having to increase its borrowings, we think it is very important for the company to channel the proceeds into earningsaccretive projects to minimize the impact of the earnings dilution from the enlarged share base. RHB Research | See important disclosures at the end of this report A comprehensive range of market research reports by award-winning economists and analysts are exclusively available for download from www.rhbinvest.com 12 Powered by Enhanced Datasystems’ EFA Platform
RHB Research FORECAST & RECOMMENDATION Decent top- and bottomline growth. We expect revenue to grow by about 28% y-o-y in FY13, largely driven by the strong revenue recognition from its existing ICT & projects backlog as well as from new contract wins. As such, the ICT & projects segment is set to remain its biggest revenue contributor, bringing in over 70% of its total revenue. Loxley’s trading and service businesses contribute less than 30% to its total revenue. We expect the gross margin for its core business to improve slightly in FY13, with further improvements in FY14 onwards as the company achieves greater economic of scales from the high backlog of its ICT business segment. Overall, we expect net profit to grow at around 27% over the next few years, in line with revenue growth as well the higher equity profit contributions from its JVs and associate companies. Conservatively, we have not factored in contributions from its online lottery business in our forecast due to the uncertainties surrounding the issue. Initiate with TRADING BUY. We initiate coverage on Loxley with a Trading Buy call and a FV of THB10.60, based on 3.6x FY13 P/BV. This is equivalent to a 10% discount to the average P/BV of its peers AIT and SAMART. While Loxley is an integrated ICT contractor just like AIT and SAMART, we think the discount is reasonable, taking into account its position as a diversified conglomerate compared to its peers, who are pure ICT players. The discount also factors in its relatively lower profitability compared to its peers. Nevertheless, as one of the leading ICT contractors, we think Loxley is set to benefit from the sector’s favourable outlook, supported by the abundance of highpotential opportunities available. However, the execution risk it faces in turning the high backlog into profit remains a key concern. Figure 3: Loxley’s P/BV trading band since 2003 Source: Bloomberg RHB Research | See important disclosures at the end of this report A comprehensive range of market research reports by award-winning economists and analysts are exclusively available for download from www.rhbinvest.com 13
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