Rotary Engineering's order book trending downwards since 2010

Global uncertainty. The recent worries over European sovereign debt issues and the slow-down in the US economy have led to a sharp sell-down in stock markets around the world. The global uncertainty has also increased the volatility of oil prices.

Nevertheless, oil prices (WTI crude) continue to trade around US$80-90/bbl, still above the threshold level (US$60-75/bbl) that supports on-going capex for exploration and production activities. Although downstream EPC companies such as Rotary are not directly impacted by the movement of oil prices, they could still be affected by lower demand for infrastructure projects at petrochemical complexes and tank terminals.

Low clarity in demand situation. Rotary's key markets are the Middle East (64% of FY10's revenue) and Singapore (28%). The Middle East region, particularly in Saudi Arabia and UAE, has been looking to develop its own refining and chemical processing facilities to move away from being just a crude oil exporter. This has resulted in robust demand for EPC works over the past few years.

In contrast, there have been fewer large EPC projects in Singapore. Competition within Singapore also has been very stiff, resulting in narrower margins. Of late, the global uncertainty has also led to delays in the commencement of several infrastructure projects. If the uncertainty persists or intensifies, we could see potentially see more delays in EPC projects.

Slimmer order book. Rotary's order book has been trending downwards since 2010. At S$737m (as of 1H11), we believe the current order book mitigates only part of the downside risk of demand falling off. The key concern is the sustainability of its contract wins, which would in turn affect its revenue growth over the next few years. Larger EPC contracts typically have a lead time of about a year. Supposing if Rotary wins fewer contracts over the next few quarters, the company's

Maintain HOLD with revised S$0.66 fair value. Given the higher downside risk, we cut our FY12 earnings estimates by 20%. In terms of valuation, we note that the company's shares traded at an average PER of 5.4x during the recent global recession in mid-2008 to late-2009. We are currently not in a global recession, but to reflect the more cautious market sentiment, we lowered our PER peg to 7x (down from 8.5x previously) and obtained a fair value estimate of S$0.66. Maintain HOLD.