This article first appeared in The Edge Financial Daily, on November 4, 2015.

Success Transformer Corp Bhd 
(Nov 3, RM2.09)
Recommend trading buy with a fair value of RM2.80: The company’s revenue had grown 13.4% on average for the past three years — from RM295.6 million in the financial year ended Dec 31, 2012 (FY12) and RM322.7 million in FY13 to RM371.4 million in FY14. 

We believe this was mainly attributed to increasing demand for the company’s products. 

For the first six months of FY15 (1HFY15), the company still managed to register a mild year-to-date (YTD) growth of 3% to RM195.3 million despite a decline in sales of process equipment. For 1HFY15, its process equipment segment merely accounted for 30% of its total revenue, as opposed to a range of 33% to 35% for the past three years. 

Success Transformer and its 65%-owned subsidiary, Seremban Engineering Bhd (SEB), also enjoyed compound annual growth rates of 8.8% and 26.3% respectively for their net profits from FY11 to FY13.

The slower growth in the process equipment segment could be due to a drag in a process equipment project in Sabah.

The group’s FY14 earnings declined 14.9%, undermined by losses arising from cost overruns of the project. As a result, the net profit margin (NPM) of Success Transformer only stood at 6.6% and 7.5% as of FY14 and 1HFY15, in contrast to a range of 9% to 9.6% in the past three years.  

We understand this trend may be reversing in 1HFY16, as most of the expenses related to the Sabah project have been incurred. Its NPM should gradually improve.

For instance, without such project losses, Success Transformer would have seen a better FY14. 

Ignoring the reported net losses of SEB of RM5.9 million in FY14, Success Transformer could have registered RM3.8 million more in net profit to RM28.5 million in FY14, dropping 1.6% year-on-year (y-o-y).  

The same trend was also seen in 1HFY15 numbers. YTD, Success Transformer registered a lower net profit of RM14.7 million (-12% y-o-y) as opposed to the previous year’s net profit of RM16.7 million, while SEB recorded net losses of RM6 million in 1HFY15, compared to last year’s net profit of RM2.3 million. 

Without the drag from SEB, Success Transformer would have achieved a net profit of RM18.6 million in 1HFY15 (+11% y-o-y), representing an NPM of above 9%.

SEB is also in the midst of disposing of its 40% equity interest in Selekta Spektra Sdn Bhd for a cash consideration of RM10 million. 

We believe Success Transformer’s profitability should grow stronger beyond FY15. The group should be able to deliver an average top-line growth of 9.5% to 10.5% from FY16. 

As such, we estimate its revenue to register RM408.2 million (+10.3%) for FY16 and RM446.4 million (+9.4%) for FY17 from RM370.2 million in FY15E (estimated) (-0.3%). 

Coupled with the turnaround of SEB and conservative normalised NPMs of 8% and 9% for FY16 and FY17, the group’s net profits are estimated at RM31.9 million and RM39.7 million. This represents an improvement from FY15E net earnings and NPM estimate of RM26.5 million (+7.5%) and 7.2% respectively.

As for dividends, we only impute a net dividend per share (NDPS) estimate of four sen for the next few years, including FY15, which is in line with its historical NDPS trend of three to four sen for the past three years — a yield of 1.9%. 

Based on our FY16 forecast earnings per share of 26.6 sen, the stock is trading at 7.7 times price-earnings ratio (PER), which is not excessive vis-à-vis the FBM Small Cap Index’s average forward PER of 8.4 times. Should the group show concrete signs of a turnaround, we would not be surprised to see a rerating of its valuation, say, to 10.5 times PER, which is the FBM Small Cap Index’s three-year forward PER high. — Kenanga IB Research, Nov 3