Initiating Coverage 16/6/2006 PRICE S$1.81 BUY (Fair Value: S$2.01)!"!" Investment Summary Inter-Roller Engineering (Inter-Roller) is one of the major players in the design and manufacture of Airport Logistics Systems such as Airport Baggage Handling Systems, In-flight Catering Systems, Air Cargo Handling Systems and Parcel Handling Systems.!"! $ $%&'&% (&%)*+&% %%*&%,%%---&% 7.5 % '.(/0.12 3--4*-" 4.1 $& 0/0 0/0.%)&% 0/04*-" Inter-Roller is a beneficiary of Asia s aviation infrastructure boom. Keen competition amongst airports, the emergence of budget airlines and heightened security over terrorist attacks has prompted Asian governments to make new investments in aviation infrastructure. We like the group for its strong industry position, decent dividend yield and exciting growth prospects. Inter-Roller has proposed a stock split of two for one. This proposal is subject to shareholders approval at an EGM to be convened and also from the SGX. The stock split will increase the liquidity of the shares and is positive for shareholders. ' (!)!* )%%-! 5%-%% 6- (%%-! 78&*9 :*4-*-%)% '%*" * 1!-*4* "$$! ;5<;=5 " 5;!>) '/)./'( 5+=8? " ;5<;=5 34/).'3 >8@%%.5 " 5;7 /'( We expect Inter-Roller to grow its earnings by a compounded rate of 24.2% p.a. over the next three years. Given the strong growth we are projecting, its forward PER of 13.1 times looks reasonable. Our valuation for the stock based on a DCF model, assuming a discount rate of 8.5% on the free cash flow, gives a fair value of $2.01 for the stock. Our fair value represents an 11% premium over the current share price. Together with the forecast dividend yield of 4.1%, the potential upside to the current price is 15.1%. We initiate coverage on this stock with a BUY recommendation. Yeo Keng Huat 1
Company Profile Inter-Roller is a total solutions provider delivering a comprehensive suite of engineering and design services which includes system and capacity evaluation, system conceptual design, detailed engineering design, computer simulation, manufacturing, project implementation as well as maintenance services. It is a major player in the design and manufacture of Airport Logistics Systems such as Airport Baggage Handling Systems, In-flight Catering Systems, Air Cargo Handling Systems and Parcel Handling Systems. Inter-Roller manufactures the equipment out of two factories, one at its headquarters in Singapore and the other located in Malaysia. Its Singapore office has over 14,000 sqm of space dedicated to production. In Malaysia, the factory space is some 19,400 sqm. An extension of the factory space in Malaysia was built and completed last month. This increased total factory space to over 40,000 sqm. Inter-Roller has subsidiaries and offices in the United Kingdom, United Arab Emirates, Hong Kong and China, offering full project management, operations and maintenance support services. Staff strength currently stands at 673, comprising highly skilled and experienced engineers and design specialists. Inter-Roller has a strong international track record which includes successful projects in Asia, Africa, Australia, Europe, Middle East, Caribbean Islands and Latin America. It boosts a customer list that includes Singapore Changi Airport, Dubai International Airport, Hong Kong International Airport and Beijing Capital International Airport. Last November, Inter-Roller acquired a 100% stake in CDG Systems Limited in UK. CDG air cargo systems has more than 30 years of track record in Europe. It is one of the UK s leading systems for manual, semiautomated and fully automated air cargo handling. This acquisition will help Inter-Roller expand its air cargo business and enable it to gain a foothold in Europe for its baggage handling systems as well. Industry Outlook Asia s passenger traffic is expected to be the fastest growing in the world as increasing affluence in China, India and Middle East countries have led to an increasing number of people travelling. Air cargo movement is also expected to grow at a strong pace as inter-regional trade continues to grow. As existing aviation infrastructure is not able to cope with the increasing traffic flow, new investments in airports are being planned by governments across the region. This increased investment is expected to be sustained in the long term. According to the International Air Transport Association (IATA), global passenger traffic growth rate is expected to be 5.6% between 2005 and 2009, with the fastest growth coming from Asia. For air freight traffic, the growth rate is expected to be 6.3%, with Asia being the fastest growing region. +, -./ 0 12 3-44+5 :*@* )1*& :% && ' 1% && ' 7--* '% ' 1& >)1%&& Source: IATA 2
+4$, -./ 0 12 3-44+5 :* @* )1*& :% && ' 1% && ' 7--* '% ' 1& >)1% && )1& 51& >)' >)5 1& 7--*'% 1%&& Source: IATA Breakdown of Turnover Inter-Roller has more than 10 years of experience in the design of airport logistics systems. It has handled more than 40 customised projects in 20 countries. The following table shows that Inter-Roller has a presence in almost all the major regions in the world. Turnover by geographic region % FY 04 FY 05 S$'000 S$'000 Singapore 35.04% 23.61% Other Asean countries 42.54% 16.12% China 8.37% 14.30% Middle East 7.33% 36.62% Latin America 0.00% 8.22% Africa 3.40% 0.00% Europe 1.08% 1.03% Others 2.24% 0.10% 100.00% 100.00% Source: Company Growing order book As at 31 March 2006, the outstanding order book stands at S$189m. The following are some of the major projects it has clinched: Changi Airport Terminal 3, Singapore The Baggage Handling System at the new Changi Airport Terminal 3 will be completed in 2006. Designed to accommodate passenger traffic of up to 20m passengers a year, the System comprises 135 check-in positions with more than 6km of transport conveyors. It has a fully automated departure control system, high-speed inter-terminal transfer system, and an early bag storage system. The system allows the baggage of transfer passengers making connections at different terminals to be transported from one terminal to another within three minutes. Yangon Airport, Myanmar In September 2005, Inter-Roller was awarded a contract to design and build a complete arrival and departure Baggage Handling System for Yangon Airport in Myanmar. The project is scheduled to be completed in 2006. Beijing Capital International Airport, China In 2005, Inter-Roller secured a contract to design and build part of the Baggage Handling System for the new Terminal at Beijing Capital International Airport. The airport is targeted for operation before the 2008 Beijing Olympics and will have a handling capacity of 60 million passengers a year. Hong Kong International Airport (Skyplaza Building) In January 2005, Inter-Roller secured a contract to design and build a new Baggage Handling System at Hong Kong International Airport s Skyplaza Building. This is a new terminal designed to increase the passenger handling capacity of the existing Chek Lap Kok International Airport in Hong Kong. 3
Dubai International Airport, United Arab Emirates The rapid growth of air traffic at its airport has prompted the government of Dubai to commit to a major expansion plan of the Dubai International Airport. The expansion program includes the upgrading of Terminal 1 and 2 and the construction of the new Terminal 3, Concourse 2 and Concourse 3. When the expansion works are completed, Dubai International Airport will have a passenger handling capacity of 70m a year. The airport will also be capable of handling the new Airbus A380 Super Jumbo. Works started in 2005 and is scheduled for completion in 2007. Manchester Airport Terminal 1, United Kingdom In late 2005, Inter-Roller secured an order to develop a design for a fully automated Baggage Handling System. The contract calls for the designing, supplying and commissioning of modification and upgrading works to the Baggage Handling System of the existing Terminal 1 of Manchester Airport. The project will increase the annual passenger handling capacity of the airport by providing additional check-in conveyors, arrival carousels, baggage screening equipment as well as extension of the current Baggage Handling System and Sortation lines. Curacao Hato International Airport, Caribbean Islands Inter-Roller secured a contract to deliver a Baggage Handling System incorporating a Hold Bag Security Screening System to Curacao Hato International Airport in the Caribbean Islands in 2004. The project will be completed by 2006. Tocumen International Airport, Panama Inter-Roller secured a contract to design and build a Baggage Handling System for Tocumen International Airport, Republic of Panama. This is Inter-Roller s first project in the Latin America and is due to be completed in 2006. Emirates In-flight Catering System, Dubai Inter-Roller was selected to design and build the inflight catering system for Emirates Airlines in year 2004. The scope of supply includes a High Bay Bin Handling System, High Bay Pallet Handling System, Cold Room Mobile Pallet Racking System as well as Intra-floor and Inter-floor lifts for efficient transport of bins. It is scheduled to be completed in December 2006. DHL Express International New Bangkok Airport Hub Materials Handling System, Thailand Inter-Roller secured the contract to expand and upgrade the Materials Handling Equipment System of DHL Express International at its new Bangkok Airport Hub in Suvarnabhumi Airport. The project will increase the speed, efficiency, and reliability of DHL s operations at the hub. The logistics will complement the company s newly-opened Central Asia Hub at the Hong Kong International Airport and serve the regional Southeast Asian market. Financial Performance The Group registered a strong performance in FY05. Revenue increased from S$69.9m to S$101.2m. The bottom line also grew from S$10.0m to S$16.9m. We are projecting revenue of S$135.9m and net profit after tax of S$22.6m for FY06. This is an increase of 34.3% in revenue and 33.8% in net profit after tax over FY05. We believe this strong growth forecast is reasonable based on its strong order book which stands at S$189.0m as at 31 March 06. Going forward to FY07, we are projecting revenue of S$169.5m and net profit after tax of S$28.4m. This is an increase of 24.7% in revenue and 25.5% in net profit after tax over FY06. As we believe that the airport infrastructure boom is sustainable in the long term, we are bullish on the long term prospects for the Group. 4
Relative Valuation The top four global players in the airport logistics industry have a market share of about 75%. These top four players are Siemens Logistics, FKI Logistex, Vanderlande Industries and Inter-Roller. As the logistics arm of Siemens and Vanderlande are not listed entities, we are comparing Inter-Roller with FKI. As can be seen from the table below, the PER of FKI is 10.1 times while the PER of Inter-Roller is 13.1 times. On a price-to book ratio and dividend yield basis, Inter-Roller is also more expensive. However, Inter-Roller is a smaller company than FKI and thus has a higher growth rate. In our opinion, the higher relative valuation is justifiable. Our valuation of the stock is, however, based on a Discounted Cash Flow (DCF) model (please see below DCF Valuation and Recommendation). 6! %* '7 $ 8 5 &! 5 '9 5 7!!!/ 9 %.0 0=@*& 5- %&*A%!!B )-+C*)-*!,$ %&% -%+-!!!%&%&*-! )-%!B&B %*BC& @ *!,3 *)-*!B)-*!B Source: Bloomberg, NRA Estimates (Prices as at 15 June 2006) Stock Price Performance Inter-Roller s stock price performance has been strong since last year. It hit a high of $2.28 last month before the recent bearish market sentiment caused it to decline to a low of $1.55 before recovering to the current price of $1.81. Even with the current price correction, its stock price performance has outperformed the market by a wide margin as investors bought shares on the positive expectations on the growth of the aviation infrastructure industry. We believe that this price correction is a good opportunity for long term investors to accumulate the shares. Inter-Roller has proposed a stock split of one existing share into two shares. This proposal is subject to shareholders approval at an EGM to be convened and the Singapore Exchange Securities Trading Limited. The stock split will increase the liquidity of the shares and is positive for shareholders. 5
DCF Valuation and Recommendation We forecast revenue of S$135.9m and S$169.5m for FY06 and FY07 respectively. This represents 34.3% and 24.7% top-line growth for FY06 and FY07 respectively. We also forecast net profit after tax of S$22.6m and S$28.4m for FY06 and FY07 respectively. This represents a 33.8% and 25.5% earnings increase for FY06 and FY07 respectively. Earnings per share for FY06 and FY07 are forecast to be 13.78 Singapore cents and 17.3 Singapore cents respectively. At the current price of $1.81, the PER is 13.14 times and 10.46 times for FY06 and FY07. We also forecast free cash flow of 3.09 Singapore cents and 3.46 Singapore cents for FY06 and FY07 respectively. We also forecast dividend of 7.5 Singapore cents for FY06 and FY07. We do not, however, rule out the possibility of higher dividends. The forecast dividend yield is a decent 4.1%. Our valuation for the stock, based on a DCF model with a discount rate of 8.5%, is $2.01 a 11.0% premium to the current stock price. At this fair value, FY06 PER is a reasonable 14.6 times. Including the forecast dividend yield of 4.1%, there is a 15.1% upside to the current stock price. We initiate coverage on the stock with a BUY recommendation. Key Investment Risks (1) Inter-Roller is in the aviation industry which is notorious for its vulnerability to security concerns like terrorist attacks, disease outbreak like SARs, high oil prices, etc. Our forecast assumes that the absence of such major shocks to the aviation industry. Should any of the major shocks occur, our forecast will be adversely affected. (2) Inter-Roller operates and sells its products and services in several countries and transacted in foreign currencies. As a result, it is exposed to movements in foreign currency exchange rates arising from normal trading transactions, primarily with respect to US Dollars, Euro Dollar and Japanese Yen. Forward foreign exchange contracts are entered into to manage foreign currency exposure. Nonetheless, such risks cannot be fully hedged away. For example, in FY05, the Group recorded a gain of $1.39m in translation of foreign currencies and on changes in the fair value of hedged items. In 1Q06, a foreign exchange gain of $329,000 was recorded. The Group s future earnings will be similiarly exposed to the exhange rate fluctuations. Should exchange rate movements move against the Group in the future, its earnings will be adversely affected. 6
Profit & Loss Statement!!12 3 :; :; :; :; :; (7 B B B B B 7*%B%6%&&C)-&&% B B B B B + B B B B B @%C%& ()!& &%% B B B B B 3&-% B B B B B <$ B B B B B % B B B B B $ 6 B B B B B => B B B B B 66*%))*-% B B B B B Balance Sheet Summary of Cash Flows 412 &%%% @% :-&6*% :-46*%!! 12 (!/%) 0*+ @%!/%) 0*+ 3 - '*! :; :; :; :; B B B B B B B B @4-4% &6*-4% 46*-4% /%)&4&*-4% / $+!%-). /%)CD*% -6.D4" " /%) 0/%)0*+ B B B B 0/%) 0*+.) &% 0/%)0*+ ;*- " " " " 2&% ))*-%9D4E7@ D4" " " 7
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