Rotary Engineering hit by middle east turmoil

Concerns about Middle East exposure may have been overblown. The unrest in the Middle East has spooked investors. Rotary Engineering's (Rotary) share price has fallen by some 21% since the beginning of this year, largely due to investors' concern over its Middle East exposure. Saudi Arabia and UAE accounted for 50% and 39% respectively of its current order book. However, these concerns may have been overblown because both countries, unlike Egypt, Tunisia and Libya, are less affected by the civil unrest presumably due to higher levels of wealth among its residents.
Rotary's management has also reiterated that its operations in that region were not impacted by the civil unrest.

Strengthening core capabilities. In recent years, Rotary has expanded and deepened its overseas operations, particularly in Saudi Arabia and UAE. Its mega project, worth US$745m, to build oil storage tanks in the SATORP oil terminal at Saudi Arabia-Jubail City is currently in the construction phase and on track for completion in 4Q12. This project is the largest undertaken by Rotary. We believe that its successful execution would bring about greater recognition for its EPC capabilities in the region, which would in turn result in greater opportunities for project tenders and collaborations with large international upstream oil producers and construction/engineering companies. Rotary is also looking at expanding into new markets such as Turkey, and exploring more build-to-operate/transfer (BOO/BOT) opportunities in the Middle East and ASEAN regions.

Sound financial fundamentals. Rotary's financial fundamentals remained sound, despite some distortion in the 1Q11 results due to the (i) lumpy nature of project revenue recognition and (ii) increase in days sales outstanding as a result of the contractual terms relating to the SATORP
project. As of 1Q11, its balance sheet remains fairly liquid, maintaining a large amount of cash (S$115m) and utilizing a modest amount of debt (S$15m). Management acknowledges some margin pressure and attributes this to stiffer competition, particularly in downstream projects in Jurong Island. However, as local projects account for only 10% of its current orderbook, we believe the group would be able to maintain its margin.

Reiterate BUY; fair value of S$0.99. Although Middle East is a key concern, we note that its exposure is predominantly in Saudi Arabi and UAE, which are less affected by political upheavals and civil unrest. We reiterate our BUY rating with fair value estimate of S$0.99, valuing the group's
shares at 8.5x forward PER.