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Favelle Favco Berhad Industrial Product | Cranes Manufacturer Stock Code: 7229.KL Malaysia

BUY

Current Price RM 2.33 Target Price RM 2.75 Est. Upside Potential 17.82% Market Cap RM 511.51m 52-week Range RM 2.26 – RM 3.21 Average Volume 144,800 Shares Outstanding 219,531,000 Free float 37.89% Beta 1.31 Valuation Basis Relative Valuation

Investment Considerations 1) Trading environment might be challenging but infrastructure needs in Asia might outweigh the risk.

With the sharp deterioration in order book (decline from over RM 1billion to around c. RM 600million) reflects challenging environment and has weakened investor’s sentiment. As shown later, the decline, to certain degree, is associated with weak oil price. We believe this is a risk, however, infrastructure needs in Asia remain high. Recent establishment of Asian Infrastructure Investment Bank with the aim to bridge the infrastructure gap (estimated to be USD 8 trillion) in Asian economies may create an opportunity to shift Favco’s revenue mix away from Oil and Gas industry to take advantage of such infrastructure gap. How successful will depend on whether it can tap into this market. We view the brand as being strong due to its cranes were involved in construction of numerous high profile skyscrapers such as Burj Khalifa and World Trade Center.

2) Attractive valuation supported by good fundamental.

Enterprise value is currently trading at 1.77x EBITDA with ample cash in hand. The company has outperformed the international competitors in various metrics such as profit margin, cash flow, leverage and investment despite being a smaller player. PE is currently trading at 6.21x while Malaysia’s average PE is 18x (source: http://www.starcapital.de/research/stockmarketvaluation). Our valuation basis is based on relative value since we believe its earnings and cash flows are difficult to forecast in short to medium term due to the uncertainty. We could use scenario analysis on expected cash flow but that would be just be anchoring random numbers which may not produce reliable results.

3) Recent litigation has no financial impact and immediate risk to the reputation.

Carigali Hess is seeking compensation of c. USD 6.3million in relation to an incident involving a Favco crane. However, the company explained such loss is covered by insurance hence no immediate financial impact on its upcoming financials. Intangible loss to its reputation is too early to assess, however, it is partly mitigated by its track record in the involvement of several mega projects.

Analyst Jackson Yuen

Contact +44 7400 630 379

Email jacksonyuen1234@gmail.com

Date 26/08/2016

KapitalWise

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Company Profile

Favco is a manufacturer of construction cranes and

product lines include Tower Cranes, Offshore

Cranes, Crawler Cranes and Wharf Cranes. Operate

under two brands (Favelle Favco and Kroll) and

reported to have the largest hammerhead crane and

luffing tower crane in the world. It has four

manufacturing facilities with 700 workforce.

Top 5 Shareholders

Muhibbah Engineering (M) Bhd 59.71%

Kumpulan Wang Persaraan 2.44%

Mac Ngan Boon 2.40%

Yayasan Hasanah 2.38%

Employees Provident Fund 1.76%

* As of 31 December 2015

CRAWLER CRANES - Heavy lifter with the ability

to move. Favco teamed up with Caterpillar Industrial Products Inc for crawler cranes. There are two models, Lattice Boom and Telescopic Boom. Telescopic Boom is highly manoeuvrable and easy to move loads to places hard to reach. Lattice Boom is more for heavy lifting (forklifting).

TOWER CRANES - Mainly for

construction usage to lift building materials. Kroll brand specializes in electric hammerhead cranes, size range from 70metre tonnes to 25,000metre tones Favelle Favco brand specializes in high speed diesel hydraulic luffing cranes, size range from 60metre tonnes to 2,000metre tonnes. Luffing cranes have the advantage to lifting the jibs vertically whereas normal cranes’ jibs are fixed thus very inflexible.

WHARF CRANES - Favco builds

cranes for shipyard and port industry. Same as the Tower cranes, they offer luffing and hammerhead cranes. Lifting up to 25,000metre tonnes.

OFFSHORE CRANES - Offshore and subsea

cranes are used by oil and gas which contributes majority of Favco’s revenue. It reported to deliver 80 cranes per year, capacities ranging from 5 tonnes to 2,000 tonnes. These cranes are built for harsh environment with strong enduring of offshore wind while keeping it lightweight.

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Background of Major Shareholder

The company is highly dependent on the oil and gas industry. The order book decreased substantially from the peak of RM 1.113billion which reflects the oil and gas (O&G) is placing capital expenditure reduction as their priority as they attempt to weather this oil price collapse. Prior to 2014 Q3, Favco used to report in its quarterly report that the majority of order book is contributed by O&G industry but no longer discuss O&G industry contribution after the oil price collapsed. It may attempts to comfort investors’ sentiment by ‘disassociating’ itself with O&G companies (or at least create an impression of not overly relying on O&G companies).

Segment reporting does not show revenue contribution by product lines and industries.

It only report on the countries which is quite limited for analysis purposes.

The quarterly revenue is quite fluctuating. There is a noticeable and considerably drop in most recent quarter result

- Major shareholder in Favelle Favco Berhad (59.71% shareholding) - Founded in Malaysia in 1972 (over 40 years of operations) - Listed on KLSE in 1994 (current market cap: RM1.04b) - Engage in the provision of O&G, marine, infrastructure, civil and structural engineering contract works. - Majority shareholders include Lembaga Tabung Haji (10.41%), CIMB-Principal Asset Management (3.42%), and FIL Investment Management (HK) Ltd (3.05%).

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Peer Comparable

There is no direct comparable in Malaysia with Favelle Favco hence to make the peer comparable more meaningful, we attempt to compare Favco with key international players in cranes manufacturing. Below are the descriptions of the peers identified:

Tadano Ltd - Japan’s largest cranes (terrain, truck and telescopic boom crawler) and aerial work platforms manufacturer. Konecranes - Finland-based manufacturer of cranes and lifting equipment. Reported to manufactured 10% of world’s cranes. Palfinger - Austria-based manufacturer of cranes, hydraulic lifting, loading and handling systems. Manitowoc - US-based manufacturer of terrain, lattice boom crawler and tower cranes.

Key Takeaways from peer comparable:

- Favco is a well-run company with decent profit margins and satisfactory cash flow generation from revenue. o It outperformed the competitors when it comes to Net Profit Margin and ROE. o Despite it has higher than average capital expenditure (as reflected by Capex/Sales), it still able to generate

higher free cash flow (FCF) thanks to its high Fund from Operations (FFO) generation. - Relative valuation suggests the firm is currently undervalued by most metrics

o However, it must be noted that such multiple discounts may be due to its small scale of operations and network. Larger players may deserve premium due to various reasons such as wider network, better reputation, global presence and diverse client base.

- Enterprise Value multiples suggest the company is currently trading at deep discount. The company’s EV is trading at 2.53x EBITDA as of last FYE.

* The financials are based on FYE rather than Trailing Twelve Months and market capitalizations are as of the date on FYE. There may be small differences due to rounding.

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Financial Summary

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Valuation

We used relative valuation by comparing the enterprise value multiples to understand the current valuation at enterprise level regardless of the capital structure.

Excluding the extreme observations (Konecranes and Palfinger) to reduce our likelihood of overestimating the value, the average multiples are 2.82x. Currently Favco is trading at 1.77x which represents 37.23% discount. We believe such deep discount is unwarranted. Nevertheless, we do recognise that bigger players (as pointed out previously), may deserve premium due to various factors. To account for such discount, we believe a discount in the range of 10% to 20% may be reasonable due to its small scale in operations and strong tie to oil and gas industry (our expectation since the company no longer disclose its relationship in its quarterly report). However, for investors who want to stress test further, discount over 30% is the breaking point and we have included it for investor to assess the sensitivity.

Applying 10% discount suggests the share may have an upside potential of 17.82%. That is, we are ignoring any multiple expansion (in general industry) and just focusing on the multiple contraction. If Favco Berhad’s multiple reduced to let’s say 1.5x, it is a good target company by private equity (although unlikely since it is majority owned by Muhibbah Engineering (M) Bhd unless they pay high take over premium). Also such multiple contraction is not justifiable as it is a healthy company with decent cash flow generation, good track record and may potentially benefit from infrastructure needs in Asian economies. With sluggish trading outlook, its low leverage capital structure grants it some level of flexibility in financial policy underpinned by ample of cash for further acquisitions, share buyback and dividend distribution. It also has a track record of delivering satisfactory profit margin (ROE in double digit range), strong dividend coverage and robust balance sheet.

Key Investment Risks

Cutting Capex by Oil and Gas companies

Sharp drop in order book continues to weaken investors’ sentiment. We believe it could be an issue unless the company shifts its revenue mix toward construction and industrial client base to diversify concentration risks.

Strengthening MYR may discourage foreign sales

This could be a risk but partly mitigate by the correlation between oil price and MYR. Strengthening MYR may suggests oil price recovery hence it may boost capex spending by oil and gas companies depending whether the oil price recovery is sustainable.

Small player in global market

It still lacks the products provided by big players. Products such as Loader Cranes, Aerial Work Platforms and Bridge Inspection Vehicles. It prevents Favco from expanding into different sectors and more lucrative business opportunities.

Cranes accident may put its reputation at risk

Although recent litigation by Carigali Hess may have reputation risk but, as the company said, it is too early to assess the outcome. Cranes manufacturers operate in environment where quality and reputation are keys hence any further accident may weaken its brand and demand.

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Investment Ratings Buy = Share price may exceed 15% over the next 12 months Neutral = Share price may fluctuate within the range of ± 15% over the next 12 months Sell = Share price may fall more than 15% over the next 12 months Investment Research Disclaimers The opinions and views expressed in this report are solely of the analyst. Any projections or estimations may not be accurate. Market conditions and assumptions could result in materially different outcomes. Past performance is not necessarily an indicative of future performance and the analyst will not accept for any loss arising from information contained in this report. This report is not intended as an offer to buy or sell the securities discussed. Seek independent advice to understand the investment risk arising from taking investment actions based on this report. Consider your unique circumstances (such as time horizon, liquidity and risk tolerance) before investing as not all investment are suitable for every investor. The analyst currently has no financial interests with the company analysed in this report. The company has not paid the analyst to write this research. The analyst currently has no shareholding in the company analysed in this report. The analyst may invest in the company analysed in the future but will only do so after 48 hours of publishing of this report. Background of the analyst

Currently working as a Credit Analyst in the Bank of East Asia, analysing retail, corporate and syndicated loans in various industries.

Passed Level 3 of the CFA Program.

Distinction in MSc Banking and Finance from the University of Sussex.

First Class Honours in BA Accounting from the University of Portsmouth.