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Sundart International (2288.HK) - Limited Growth Engine

Wednesday, August 12, 2009

4962

Sundart International(2288)

Recommendation on 12 August 2009
Recommendation	Short-term Subscribe
Target Price	$5.100

Weekly Special - 2333 Great Wall Motor

Summary

Sundart is an integrated fitting-out contractor in Hong Kong, specializing contracting services for residential and hotel projects in HK and Macau primarily.

While HK and Macau have been well developed for years, we think there will be limited room of construction growth in the regions.

Part of the fund raised in the IPO is for future business expansion in the PRC and the Mid East. All in all, we feel neutral towards the new markets for Sundart.

We set 2009E P/E is approx. 12.5 times, implying the 12-month target price to be HK$ 5.1. Compared with the offer price, upside potential will be 22-53.2%.

Company Description

Sundart is an integrated fitting-out contractor in Hong Kong, specializing contracting services for residential and hotel projects in HK and Macau primarily. Approx. 97% of revenue came from HK and Macau projects as of Mar 2009. They are usually employed as contractor by property owners or nominated subcontractor by main contractors.

They are responsible for overall project implementation and do not directly employ workers that are rather outsourced to subcontractors. Progress payments are received from the customers periodically according to the stages of completion of the works done, and the corresponding subcontracting fees and costs for materials payable to suppliers/ contractors are settled accordingly.

Financial Highlights

Revenue merely grew by 1.5% from Mar 2008 to Mar 2009, due to the decrease in revenue derived from Macau and also high comparison base recorded in 2008. The CAGR of revenue representing 26% increase from 2007 to 2009. Albeit the decrease of revenue, profit margins hiked significantly which is due to the decrease of costs of sales.

However, we do not think the high margins can sustain in the future. First, the decline of COGS was partially due to the high comparison base in 2008, as many large projects in Macau required exceptionally high subcontracting fees and material costs. Second, approx. 67% of this came from subcontracting costs, followed by materials purchases (25%) and staff costs (4.5%). Increase in raw material price in 2009 may drive the increase of material purchases expenses again in the coming future. Third, subcontracting fees as of revenue increased progressively in past 3 years, up from 43.5% in 2007, 55.5% in 2008 to 57.6% in 2009.

Regarding the indebtedness and liquidity, net debt ratio improved in 2009, mainly attributed to the significant decrease in bank borrowings resulting from collection of retention moneys of projects in Macau. Total debt as of Mar 2009 dropped by 82.3%. As such, the financing cost reduced by 73.4% and that is the reason why the net profit jumped by almost 80% in 2009. We foresee the company will not have any liquidity pressure in the medium term.

Limited Growth Engine

While HK and Macau have been well developed for years, we think there will be limited room of construction growth in the regions. Numbers of residential house in HK and Macau have experienced negative growth since 2005 and 2007 respectively.

For Hong Kong construction sector, gross output value of construction has apparently declined since 2Q 2008, and even decreased by 0.5% in 1Q 09 from a year earlier. Construction coming from public infrastructure will be the main driving force in HK, in our view, supported by 10 mega infrastructure projects. Yet, Sundat may not benefit from this in great extent, as its business rather focuses on residential houses and hotels.

In Macau, construction sector would be bleak till the tourism revives, as construction was mainly driven by hotels and the economy was much supported by gaming sector that is driven by its tourism business. We do not expect the tourism industry of Macau can revive in the short-term, due to the restriction of visiting permit and restriction to the mainlanders. The number of tourists in Macau was down from –1% in 4Q 08 to –2% in 1Q09 and further –10% in 2Q09.

Business Outlook

Part of the fund raised in the IPO is for future business expansion in the PRC and the Mid East.

For the PRC, after the cooling down of the property market in 2007, floor space started to plunge from the peak recorded in early 2007, and it is at negative growth in the first 6 months of this year. Though there is sign that the worst may have passed through, we are cautious on this, as sales volume will retreat later due to high property prices and the probable tightening measures to curb overheating of the property market and threatening of asset bubble. Unemployment rate in Jun leveled off the figure in Mar.

In the mid-east, in particular of Qatar and Abu Dhabi, though there is strong demand of residential house to meet the surging population, the property markets are not very significant in terms of gross output value that is lower than HK's by 2.4 times to 2.9 times.

All in all, we feel neutral towards the new markets for Sundart.

Valuation

Referencing stocks of the construction and material sector (Emerging Asia region and the Mid-East and Africa), according to the Bloomberg, the median value of 2009E P/E is approx. 16x. As we consider the scale of Sundart is comparatively smaller and lack of growth potential in the medium term, we think it is reasonable to have discount on the company. Thus, we set 2009E P/E to be approx. 12.5 times, implying the 12-month target price to be HK$ 5.1. Compared with the offer price, upside potential will be 22-53.2%.

On the other hand, within the construction and material sector, we will recommend stocks which has main business operating in the PRC like Shui On Construction (983 HK) or upper stream players that are cement or building material suppliers.

Risk

1) Fluctuation of material price and subcontracting fees

2) Delay of projects completion time which may lead to compensation

3) Unexpected drop in oil price

4) Tightening measures by the PRC government on the mainland property market

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