The best time in Tat Hong’s history is NOW

Target price: SGD1.74


We are raising our earnings forecasts and target price. We are turning more optimistic on Tat Hong after meeting management. The strong performance of the past few quarters suggests that Tat Hong’s recovery is taking place even faster than we expected. We raise our net profit forecasts for the next three years on the back of higher rental rate estimates. We maintain our BUY rating on Tat Hong with a higher target price of SGD1.74, pegged to 15x FY3/13 PER.

Tat Hong is entering a multi-year growth cycle. Tat Hong is experiencing the best time in its operating history with booming demand from all countries it operates in. Current order book already provides good earnings visibility for at least the next 2 years.

Insatiable demand as infrastructure boom in Asia continues. The supply-demand profile of the crane rental industry in Asia is very imbalanced. Of the top five crane rental companies in the world, Tat Hong is the only one located in Asia; the rest are in the US and Europe. Demand-wise, infrastructure spending in Asia will continue to outpace that of Europe and the US. This supply-demand mismatch will keep Tat Hong very busy for the next few years.

Premium pricing to prevail. We understand that Tat Hong has been able to charge a premium over its competitors. This can be attributed to the higher quality of its cranes, wider range of products, a larger fleet size and less competition in the high-tonnage crane segment. We believe Tat Hong will
continue to enjoy a pricing advantage over its peers going forward, as no players in the region can achieve a fleet size comparable to Tat Hong’s in the short term.

Buying into Tat Hong’s ROE uptrend. Tat Hong has been investing heavily over the last few. We believe investors will be buying into its ROE upcycle as Tat Hong enjoys operating leverage over the next 3-5 years. Coupled with its strong and rising dividend yield, Tat Hong offers both growth and yield which is a rare and potent combination.

Recent meeting with management boosted our optimism

Insatiable demand. The supply-demand profile of the crane rental industry in Asia is very imbalanced. Of the top five crane rental companies in the world, Tat Hong is the only one located in Asia; the rest are in the US and Europe. On the demand side, as Europe is still deep in debt and no large-scale stimulus plan from the US appears to be forthcoming, infrastructure spending in cash-rich Asian countries will continue to outpace that of Europe and the US. This supply-demand mismatch will keep Tat Hong very busy for the next few years.

Dependence in Australia mining sector lower than expected. There are differing views regarding the resources boom in Australia. What may have sparked the concern about the mining boom being over is the announcement by BHP to postpone an expansion of its USD30b Olympic Dam project in South Australia. This development in itself will not have any impact on Tat Hong’s Australian operations as Tat Hong did not participate in it in the first place.

In the resources sector, although there might be some slowdown in investment in the future, we believe it is not necessary to be overpessimistic. Firstly, strong demand in oil & gas sector will partly offset some possible slowdown in iron ore and coal sectors. There are already many such multi-billion dollar projects - eg. Gorgon LNG project (AUD43m), Ichthys LNG project (AUD33bn) - that are already committed or underway. These projects once started will continue to run for many years. Secondly, according to a statement posted by China National Development and Reform Commission (“NDRC”) last week, it seems that China begins to accelerate its infrastructure projects approval again. NDRC has approved a total of 710.8 billion yuan (USD112.1 billion) worth of investments during June to August period by 18 local governments to build city subways. In addition, NDRC also approved several high way upgrade projects. If China resumes its investment mode, demand for iron ore and coal can come back easily. In fact Tat Hong’s Australian operations still see very strong levels of activity in the New South Wales in the coal mining operations.

The best time in Tat Hong’s history is NOW. Tat Hong is experiencing the best time in its history, with booming demand from all the countries it operates in. Its current project pipeline gives it earnings visibility at least the next two years.

Distribution Division:
We see strong demand from post-flood construction in Queensland, Australia, increased sales from Singaporean and Japanese traders as well as robust demand for excavators in Indonesia. Take excavators in Indonesia as an example; we expect strong sales momentum to continue. In FY3/12 Tat Hong managed to sell 400 units of excavators in Indonesia. Management is targeting sales of 1000 units this year with total revenue of around USD100m and market share of 10%.

Crane Rental Division:
Strong order flows across the region supports earnings visibility for the next two years. Tat Hong currently has sufficient projects in its pipeline, including the MRT and Jurong Island construction projects in Singapore, MRT and oil & gas projects in Malaysia, the Hong Kong-China Bridge, flood prevention barricades in Thailand as well as LNG and post-flood construction works in Australia.

In particular, the MRT projects are all very long-term, with construction still at an early stage in many Asian countries – even Singapore. In Singapore, there are currently 138km of rail lines. The government plans to invest SGD20b to develop new rail lines and extend existing lines, effectively increasing the current network length to 278km, by the year 2020. In Malaysia, government plans to spend around MYR50b to build a three-line rail network, which is expected to be completed in 2020.

Good mix of new and old cranes. In our view, the age profile of Tat Hong’s cranes is optimal, at an average of 6-7 years. That is another reason why they can charge a slight premium. On the other hand, around 15% of its cranes have been fully depreciated but are still in good condition, meaning that rental income from these cranes is almost fully translated to the bottom line.

Slightly skewed towards high-tonnage cranes. While low-tonnage cranes (below 100 tonnes) are still the biggest component of Tat Hong’s crane portfolio (56% in terms of number of crane units), we notice that Tat Hong has purchased a few high-tonnage cranes in the past few months, making high-tonnage cranes account for a slightly bigger proportion of the whole portfolio. This is a step, in our view, to further strengthen its competitive advantage over its peers because higher-tonnage cranes are more difficult for small players to afford, thus Tat Hong can charge a higher than proportionate rental compared with low-tonnage cranes. Meanwhile, management has guided for capex of SGD100m in FY3/13, of which SGD70-80m would be used to purchase cranes.

Sustainable pricing power
Pricing premium over competitors. We understand that Tat Hong has been able to charge a premium over its competitors. This can be attributed to the higher quality of its cranes, a wider range of products, larger fleet size and less competition in the high-tonnage crane segment. In our view, price is not the only element that contractors consider when they choose crane provider. Crane quality, reliability and timely delivery, a wide variety of products which can meet different requirements as well as a long-term relationship, are also key factors. Tat Hong’s large fleet size, wide range of products and services and good track record convince us that it can continue to enjoy some pricing advantage over its competitors going forward, as no competitors in the region can achieve a size similar to Tat Hong in the short term, in our view.

Recovery in rental rates ahead of our expectations. Management cannot share with us actual rental rates due to the sensitive nature of this information. But based on our estimates, by the end of FY3/12, Tat Hong's crane rental rates had recovered to SGD403/tonne/month, representing 84% of its peak level of SGD481 in FY3/08. We had long believed that crane rental rates had gained momentum; however, the improvement in Tat Hong's 1QFY3/13 results still surprised us. Average rental rates in the April-June quarter reached SGD480/tonne/month on our estimates, 19% above the average rate of the past financial year. Although all the numbers above are estimates, we have sufficient reason to believe that they are not far from the actual numbers.

Aggressively raising rental rate assumptions for the next three years. We raise our rental rate assumptions for the next three years by 14.6%, 15.7% and 15.7% respectively on the back of sooner-thanexpected rental rate recovery. Despite the significant increase, our rental rate estimates may still be quite conservative, as our full year rental rate forecast has already been achieved in 1QFY13.

Increasing our earnings forecasts. We raise our FY13-15 revenue forecasts by 6.7%, 4.9% and 3.4% respectively as we become more optimistic on the company’s outlook. Accordingly, our net profit forecasts have increased by 19.2%, 13.3% and 2.7% respectively.

65m convertible preference shares are in the money now. Tat Hong issued 65m convertible redeemable preference shares (“CRPS”) to a PE fund called AIF Capital in 2009. The issue price of each CRPS was SGD1.00. The table below shows some of the terms in CRPS agreement. Now the CRPS is in the money already, thus it is possible for AIF to convert its CRPS to common shares in the near future. If Tat Hong’s share price keeps rising it is also possible to trigger the mandatory conversion. However we have already factored in this CRPS effect into our forecast and our EPS calculation is based on fully conversion of CRPS.

Recommendation and valuation Maintain BUY.
We continue to like Tat Hong’s exposure to the booming infrastructure activities in Asia, its geographical and industrial diversification as well as pricing power vis-à-vis competitors. We believe investors will be buying into its ROE upcycle as Tat Hong enjoys operating leverage over the next 3-5 years. We raise our target price to SGD1.74 based on 15x FY3/13 PER.

Backed by strong assets. We believe potential share price downside is quite limited, as the physical assets (mainly the cranes) that Tat Hong owns provide solid valuation protection. Based on our estimates, Tat Hong’s 755 mobile cranes are worth SGD700m vs. its current market cap of SGD581m.