• Keep NEUTRAL and DCF-based SGD0.08 Target Price, 8% upside plus 2% yield.
• GSS ENERGY LIMITED (SGX:41F)’s 2Q19 profit of SGD0.087m stemmed from price competition and cost-down pressures, which shrunk margins, as well as higher depreciation costs from new machines. We expect margins to continue being weak due to the current trade climate, worsened by the US-China trade war.
• Management will focus on the precision engineering business after the disposal of its 80% stake in GSS Energy Trembul.

Margins Were Impacted Negatively

• Margins were impacted negatively by cost-down pressures and stiff competition. Revenue continued to be lower – by 5.7% y-o-y – due to weaker demand, while margins narrowed to 15.4% in 2Q19 (2Q18: 20.4%). This was mainly due to stiffer price competition, cost-down pressures from customers, and changes in its product mix.
• Going forward, margins should continue to be weaker due to the current challenging climate, especially with the escalation of the US-China trade war.

Disposal of An 80% Stake in Its Oil & Gas Business

• GSS Energy’s oil & gas wing has suffered many setbacks and delays throughout the year. Management has now managed to farm out an 80% stake at a nominal value of USD1. However, the purchaser will have to settle the USD3m in loans that the company has, as well as pump in further capex to monetise the current and future wells that GSS Energy has a 20% stake in.
• It will also have to pay back the capex the company has since put into the project – this will be from the proceeds of the first sale of either oil or gas to the Indonesian Government. This will help remove the losses drag on GSS Energy’s PATMI and allow management to use its cash flow to further expand its precision engineering business – instead of channelling it into the oil & gas segment, as was done previously.

A Challenging Year Ahead

• With 2Q19 margins remaining quite weak, coupled with the tepid macroeconomic outlook, we expect FY19 to be a tough year for GSS Energy.
• Overall, margins should be weaker y-o-y, and revenue will likely continue to be impacted negatively – unless there is a sudden change in global sentiment or an upturn in the trade war. As such, we maintain our recommendation and Target Price on this counter.
• Key risks: The downside to our call is an increase in oil prices, the trade war worsening, and a delay in the monetisation of its oil & gas assets. The reverse of these factors should be upside risks. We are also the only broker covering this counter.

Source: RHB Invest Research - 20 Aug 2019