Rotary prices at three-year low

Fair value S$0.50


Share prices near historical lows
Rotary Engineering Limited (Rotary)’s share price plunged by 22% in the last month (May 2012) against STI’s 7% and FSTOG (STI Oil & Gas Index)’s 9% declines. We believe that this was mainly due to its disappointing 1Q12 results, continued uncertainty in the global economy and investors’ preference for defensive non-cyclical counters. As of 4th June 2012, Rotary’s share price has again fallen to a three-year historical low of S$0.50, representing almost 1x P/B (one standard deviation below its 5-year average).

Headwinds from all directions
Rotary’s business model is highly dependent on the profitability and volume of the project work it secures. Recently, it faced severe headwinds from several fronts:

(i) fewer contracts awarded by oil companies,
(ii) rising political risks in the Middle East, and (iii) a severe pricing competition. This has resulted in falling gross margins (1Q12: 14.5%; FY09-11: average gross margin of 22.2%) and net order-book (1Q12: S$0.6b; FY09-11: average order-book of S$0.9b).

More downside risks
We also see more downside risks for the group, arising from (i) additional costs on the SATORP project due to stricter-than-expected requirements, and
(ii) further delays on the Fujairah project due to engineering design variations. For the Tanjung Piai oil terminal project, we note that it is still at a preliminary stage (i.e. feasibility studies) and is unlikely to be cash generative over the near and medium term horizon.

Lower fair value of S$0.50
Although Rotary’s share price is near historical lows, we do not see any clear near-term catalyst. Moreover, we believe that there could be more downside than upside risks at this juncture. Therefore, we lowered our valuation peg to 1x (previously 1.2x) and fair value to S$0.50 (previously S$0.61). Maintain HOLD.