• Price leadership and cost synergies (post acquisition of Lee Metal in 2018) to drive BRC Asia’s net margin expansion from 0.7% in FY17 to 4.3% in FY21F.
• BRC Asia has a monopolistic grip on the supply of prefabricated steel products in Singapore, and stands to benefit from the recovery in the construction cycle.
• Highly cash generative business with minimal capex needs, in our view; we see potential for higher dividend payout.
• Initiate with ADD and Target Price of S$1.90.

Higher Margins From Stronger Grip on Reinforcing Steel Industry

• We believe the market has yet to fully appreciate BRC ASIA LIMITED (SGX:BEC)’s strengthened position in the reinforcing steel industry, post 2018 acquisition of its key competitor (LEE METAL GROUP LTD (SGX:593, Delisted)), which doubled its market share in rebar and mesh to 40-60% and 50-70% respectively, in terms of both value and volume.
• Apart from less aggressive pricing led by industry consolidation, we expect stronger procurement power and cost synergies to boost its net margins from 0.7% in FY9/17 to 4.3% in FY9/21F.

BRC Asia Company Background

• Incorporated in 1938, BRC Asia Limited is a leading solutions provider for prefabricated reinforcing steel, offering products such as 12m standard length rebar, standard and customised welded wire mesh, cut and bend services for rebar and prefabrication service for various structural elements.
• BRC Asia caters to construction companies that handle both public and private projects. BRC Asia aims to help clients cut down laborious and inefficient on-site steel fixing work, which could lead to greater on-site productivity and speed up construction projects. The company currently has operations in Singapore, Malaysia and China. It has a total of seven factories in Singapore and has an annual processing capacity of over-800k metric tons of steel as at end-FY18.

BRC Asia's Products and Services

• In the most general sense, BRC Asia purchases steel rebars from international steel mills, prefabricates it into different structural forms, such as mesh and cut & bend, and sells it to construction companies. BRC Asia’s main competitive advantages include
  1. just-in-time delivery,
  2. 24-hour express services for cut-and-bend services, and
  3. a full suite of prefab reinforcing solutions.

Investment Thesis

Reaping the benefits of the consolidation of Singapore’s reinforcing steel products industry

• In Jul 2018, BRC Asia completed the acquisition and privatisation of a major listed steel competitor, Lee Metal Group. Post-acquisition, BRC Asia has a monopolistic grip on the supply of reinforcing steel products in Singapore, in our view, with an estimated 40-60% market share in rebar and 50-70% market share in mesh (in terms of both value and volume, respectively, in 2017, according to the latest study by Competition & Consumer Commission of Singapore).
• Currently, BRC Asia is one of the two remaining “one-stop-shops” that provide both reinforcing steel products in Singapore, the other being NatSteel (TATA IN) with a 20-30% market share in rebar and 10- 20% market share in mesh, in terms of value and volume.
• Having emerged from the industry consolidation in a dominant position, BRC Asia was able to put to an end to the aggressive pricing which had plagued the industry since 2017.
• Due to the weaker steel demand in Singapore in 2017, there was intensified competition within the reinforcing steel products industry in Singapore, which resulted in many contracts being priced aggressively as steel companies attempted to increase volume to cover their fixed costs. According to management, contract pricing normalised after BRC Asia completed the acquisition of Lee Metal in 2018. As contracts secured could take up to five years to be completed, we expect BRC Asia’s margins to improve gradually as the percentage of less profitable contracts in its orderbook gets whittled down.
• We believe BRC Asia is also reaping other benefits through the enlarged scale, including:
  • Lower procurement cost of steel rebars as BRC Asia can purchase bigger volumes and negotiate for better pricing;
  • Lower unit costs at various stages in the supply chain, including logistics, sub-contractors, spare parts and scrap metal;
  • Improved productivity and efficiency in managing inventory space, and increased market competitiveness; and
  • Ability to be more selective in terms of project quality, thus lowering its credit risk profile.
• With the recovery in contract pricing and stronger procurement ability, we expect BRC Asia’s net profit margin (NPM) to normalise to a longer-term average of 4-5%. We forecast BRC Asia’s NPM to improve from 0.7% in FY17 to 4.3% in FY21F.

Proxy for SG construction sector recovery

• According to the Building and Construction Authority (BCA), total construction demand in Singapore recovered in 2018 (S$30.5bn, +23% y-o-y) after three consecutive years of decline. We think that the outlook for the construction sector in the near-to medium-term is turning positive and on a slight uptrend, with BCA projecting total construction demand (i.e. the value of construction contracts to be awarded) in 2019 to range between S$27bn and S$32bn. Total construction demand in Singapore is projected to be in the $27bn-34bn per year range from 2020-21F and $28bn-34bn per year range for 2022F and 2023F, according to BCA.
• Given a typical time lag of 12-18 months between contracts being awarded and the rollout of projects, we expect industry demand for steel to start rebounding in CY19F. Given that Singapore accounts for the lion’s share of revenue for BRC Asia (94% in FY18), a recovery in its home market is definitely good news for the company, in our view.
• As of end-Jun 2019, BRC Asia’s orderbook stood at S$1bn (end-Mar: S$750m). We estimate that the orderbook is made up of 50% public contracts and 50% private contracts. We believe that 50% of the order book will be recognised over the coming 12 months, 25% between 12-24 months, and the remaining 25% to be completed over the following three years. We forecast BRC Asia’s order book to remain above the S$1bn mark over FY19-22F.
• Historically, BRC Asia’s revenue accounts for 2-4% of the overall construction output in Singapore (with the trend highly correlated with movements in steel bar prices – correlation coefficient is 0.92, based on our analysis. The increased demand in the construction sector could translate directly to the increase in demand for steel rebar and mesh, and we believe BRC Asia is a key beneficiary from this recovery in construction activity.

International expansion

• Overseas markets accounted for 6% of BRC Asia’s revenue in FY18. Management is targeting to speed up the pace of its global expansion by expanding the company’s presence in international markets, especially China.
• Currently, BRC Asia has a joint venture in China with state-owned steel mill Ma Steel (through a 50% stake in Anhui BRC & Ma Steel Weldmesh Co. Ltd (Unlisted)). The JV mainly supplies mesh products to high speed rail projects in central China.
• Steel prefabrication as a method of construction is expected by Frost & Sullivan to gain popularity and enter a high growth phase in China, because of the government-led, nationwide push for green construction. Also, construction industrialisation is a crucial way for the construction industry to reduce reliance on labour and increase efficiency. BRC Asia seeks to leverage its extensive network and resources in China (through its related entity Rui Gang Lian Group (Unlisted), a leading iron ore player in China) to further expand its presence in the country in the medium term.
• BRC Asia also plans to leverage its expertise to broaden and deepen its reach in other Southeast Asian markets. For example, it has embarked on steel trading and distribution activities in Thailand and Indonesia in 2019.

Strong FCF generation could sustain higher dividend payout

• Given its strong cash generation ability and minimal capex needs of S$5m p.a., we forecast BRC Asia to generate FY19-21F FCF of S$0.29-0.38/share, which, in our view, will improve its net gearing from 125% as of end-FY18 to 49% by end- FY21F, as management also plans to pare down its long-term debt; BRC Asia’s recent adoption of dividend policy (at least 30% payout ratio and S$0.05/shr for FY19F) implies 3-4% dividend yield over FY19-21F.
• We see potentially higher dividend payout, with BRC Asia’s FCF dividend coverage ratio high at 4.8x-7.5x for FY19-21F (assuming 35% payout ratio).

Notable Company Developments

• The past 25 months have been a transformational phase for BRC Asia, with significant changes in shareholdings and management in 2017, followed by the successful acquisition of a major competitor.

Esteel Enterprise (Unlisted) acquires BRC.

• In Sep 2017, Esteel Enterprise acquired 95.8% of BRC Asia at S$0.925 per share. Esteel is 80.1% owned by You Zhenhua ( 游振华). Mr. You has more than 13 years of experience in the commodities trading business. He is the chairman and the executive director of Prosperity Steel United Singapore Pte. Ltd. or PSU (Unlisted), one of the largest iron ore traders in the world and is also very active in trading other commodities, including coal and nickel ore.
• PSU was first admitted in 2005 under the Global Trader Program in Singapore which provides a reduced corporate tax rate for qualified companies that have a wide trading and distribution network, and are committed to expanding their operations from Singapore.
• Esteel Enterprise is also a related entity to Rui Gang Lian Group (瑞钢联集团, Unlisted), a leading iron ore player in China. Esteel Enterprise’s ownership of BRC Asia has since been reduced to 71.7% as of end-Sep 2019.

Acquisition of Lee Metal (delisted in 2018).

• In Jul 2018, BRC Asia completed the acquisition and privatisation of a major listed steel competitor, Lee Metal Group.
• Lee Metal is a distributor and fabricator of steel products, and specialises in infrastructure projects. Total consideration for a 100% stake in Lee Metal was S$199.3m, implying a valuation of 26.6x FY17 P/E and 1.1x FY17 P/BV.
• The acquisition provides BRC Asia with a diversification of sorts within the steel and construction industry. According to management, prior to the acquisition, BRC Asia’s steel products were mainly supplied for the construction of buildings, such as HDB (Housing & Development Board) flats, hotels and industrial property.
• On the other hand, Lee Metal’s main clients were focused in the construction of transportation infrastructure, such as expressways, MRT lines, airport terminals and ports. Post-acquisition, BRC Asia now commands a strong position across the construction spectrum.

Industry Outlook

Further recovery in Singapore’s construction demand to drive steel demand

• According to the Building and Construction Authority (BCA), total construction demand in Singapore recovered in 2018 (S$30.5bn, +23% y-o-y) after three consecutive years of declines. We think that the outlook for the construction sector in the near-to medium-term is turning positive and on a slight uptrend, with BCA projecting total construction demand (i.e. the value of construction contracts to be awarded) in 2019F at between S$27bn and S$32bn. Total construction demand in Singapore is projected to be $27bn-34bn per year for 2020-21F and $28bn-34bn per year for 2022F and 2023F, according to BCA.
• The increased demand in the construction sector could translate directly to an increase in demand for steel rebar and reinforced steel, and we believe BRC Asia is a key beneficiary from this recovery in construction activity.

Major public sector infrastructure projects to set the pace

• The government is embarking on the next lap of nation-building and we think that infrastructure spending through public projects will help to stimulate Singapore’s economy amidst the global trade uncertainty. BCA estimates public sector construction demand to range between S$16.5bn and S$19.5bn in 2019F and S$16bn-20bn for 2020-2023F. This is backed by a pipeline of major infrastructure and industrial projects, including:

Changi Airport Terminal 5 (c.S$10bn total project value)

• The construction of Terminal 5 passenger terminal will begin around 2020F, according to Changi Airport Group, with completion scheduled for the 2030s. It is the biggest expansion at Changi Airport to date. The single integrated terminal will be bigger than the existing terminals at the airport, and will be built on a 1,080ha greenfield site located to the east of the existing airport.
• Thus far, architectural and engineering contracts for Terminal 5 were given out in 2018 and we think that the remaining contracts will be rolled out over 2020-22F. Works include the development of a three-runway system which will become operational in the early-2020s. Massive drains and tunnels are also being built.

Greater Southern Waterfront rejuvenation

• In the 2019 National Day Speech Rally, Prime Minister Lee unveiled long-term development plans to rejuvenate and develop the waterfront area that stretches from Gardens by the Bay East to Pasir Panjang, covering round 30km of the southern coastline. Potentially, 9,000 new residential development homes will be built at the site that is currently occupied by Keppel Club (Unlisted).
• By 2027F, the PSA city terminals at Tanjong Pagar, Keppel and Brani will be relocated out to Tuas and this will free up prime land for redevelopment. The government is also looking at plans to rejuvenate Sentosa Island, and redevelop two decommissioned power stations in Pasir Panjang.

North-South Corridor (S$15bn total project value)

• This is a major public infrastructure project that connects the north south corridor – Woodlands, Sembawang, Yishun, Ang Mo Kio, Bishan and Toa Payoh – with the city centre. We estimate the entire project to be worth S$15bn in construction value. This would lead to increased construction activities for several main contractors, subcontractors and building material suppliers that will be involved in these infrastructure projects.
• The North-South Corridor is targeted to be completed by 2026.

Extension of Integrated resorts (S$9bn total project value)

• Marina Bay Sands will be building a fourth tower, which will feature about 1,000 all-suite hotel rooms, as well a 15,000-seat indoor entertainment arena.
• For Resorts World Sentosa (RWS), the government is looking at constructing two new attractions at Universal Studios Singapore, expand the current Singapore Oceanarium and add two new destination hotels with up to 1,100 rooms. The projects are expected to be completed in 2025F, according to RWS.

Private sector construction demand holding steady

• BCA expects private sector construction demand to remain steady at between S$10.5bn and S$12.5bn in 2019, supported by projects that include the redevelopment of past en-bloc sales sites concluded prior to 2H18 and new industrial developments.
• BCA expects S$4.3bn-4.7bn of new private residential contracts to be issued in 2019F and the likely major projects include condominium developments at Outram Road, Jalan Lempeng, Amber Gardens & Dairy Farm Road. There is a steady and healthy pipeline for new private residential units and executive condominiums over 2020-23F.

China to increasingly adopt construction industrialisation

• In China, steel prefabrication as a method of construction is expected to gain popularity and enter a high-growth phase because of the government-led, nationwide push for green construction, according to Frost & Sullivan. According to BRC Asia annual report, the steel prefabrication market could grow at a compound annual rate of 14% from 2018 to 2020F.
• Drivers include:
  • Continuous urbanisation: Along with the steady growth of China’s economy and the continuous escalation of urbanisation, the urbanisation rate is expected to increase from 59.6% in 2019F to 64.9% in 2023F, according to Frost & Sullivan. As a result, construction demand will maintain continuous growth.
  • Labour shortage and cost increase in construction industry: Labour shortages and the rising labour costs have become increasingly severe challenges in the construction industry. According to Frost & Sullivan, the average age of migrant workers in the construction industry rose from 34 in 2008 to over-40 in 2018, and the average wage increased about 1.8 times for the same period. Construction industrialisation is a crucial way for the construction industry to reduce its reliance on labour and increase efficiency.
  • Increased energy conservation and environmental protection requirements in the construction industry: Enhanced environmental protection and energy conservation, as well as transformation of the development mode in the construction industry, are important directions for the future development of the construction industry in China. Prefabricated construction significantly shortens the construction period, reduces energy consumption, saves resources, and reduces environmental pollution, such as dust, noise and construction waste. The development of green construction and the requirement for enhancing energy conservation and environmental protection in the construction industry will increase the popularity of prefabricated construction.
  • Strong support from government policies: In recent years, the central and local government authorities in China have intensively introduced incentive policies to promote the development of construction industrialisation and prefabricated building. For example, the Hunan Provincial Government has proposed that by 2020, prefabricated buildings in the major cities of Hunan Province will account for more than 30% of the new buildings, while such a percentage for the downtown areas of Changsha, Zhuzhou and Xiangtan will rise to over 50%.

Financials

Recovery of Singapore construction industry to drive further topline growth

• We expect BRC Asia to record a strong topline growth of 59.4% y-o-y in FY19, with this being the first set of full-year results post the acquisition of Lee Metal in 2018.
• As of end-Jun 2019, BRC Asia’s orderbook stood at S$1bn (end-Mar: S$750m). Despite forecasting a 3.0%/2.0% y-o-y drop in steel bar price for FY20F/21F, we forecast BRC Asia’s revenue growing by 3.1%/2.5% y-o-y in FY20F/21F, supported by
  1. its strong orderbook, and
  2. further recovery of the construction industry.

Synergies from combined entity drive margin improvement

• The drop in GPM in FY17/18 was mainly due to intensified industry competition, which led to many contracts being priced at a discount as steel companies attempted to increase volumes to cover their fixed costs. According to management, contract pricing has normalised since BRC Asia completed the acquisition of Lee Metal in 2018. As contracts secured could take up to five years to be completed, we expect BRC Asia’s margins to improve gradually as the percentage of less profitable contracts in the orderbook gets whittled down.
• We forecast BRC Asia’s GPM improving from 7.9% in FY18 to 9.8% in FY21F, helped by
  1. normalisation of contract pricing, and
  2. cost synergies arising from the acquisition of Lee Metal, especially stronger procurement ability due to higher bargaining power from bigger volume purchases.
• We expect BRC Asia’s OPM to expand at a faster pace, helped by stronger economies of scale post-merger. We forecast BRC Asia’s OPM improving from 3.8% in FY18 to 6.0% in FY21F, as we expect other cost savings, including lower logistics costs through optimising warehouse utilisation and factory layout, as well as lower financing cost helped by further paring down of debt.
• BRC Asia manages its exposure to steel price volatility by
  1. entering into purchase commitments of inventories upon securing contract wins, and
  2. carrying up to four months’ worth of inventory to cover its order book.
• Management said that 85% of BRC Asia’s net profit is derived from the mark-up it charges for the supply of steel (c.2-3% net margin); while 15% is derived from the value-add portion (converting steel bars into mesh or other prefabricated steel products; 20-30% net margin). BRC Asia’s historical NPM typically averages between 4% and 5%.
• We expect BRC Asia to report net profits of S$31.5m/38.5m/41.5m in FY19F/20F/21F, representing net margins of 3.5%/4.1%/4.3% respectively.

New dividend policy offers 4% dividend yield

• In May 2019, BRC Asia announced the adoption of a new dividend policy of no less than 30% dividend payout ratio for FY19F and FY20F. The company intends to distribute dividends of at least S$0.05/share for FY19F, which implies a 37% dividend payout ratio based on our net profit forecasts. Assuming the dividend payout ratio is maintained, we forecast BRC’s dividend yield to be between 3.5- 4.5% for FY19-21F.
• However, we believe there is a possibility that BRC Asia will adopt a higher dividend payout ratio, given its strong cash flow generation capability of S$0.38/share in FY19F. This implies 7.5x FCF dividend coverage ratio (based on its dividend policy of min S$0.05/share in FY19F).
• There is also potential for a special dividend from the divestment of non-core assets in FY20F, in our view. BRC Asia has a property development business in Nassim Road as well as stakes in resort business ventures in the Maldives (one 5-star hotel and one 4-star hotel). Based on latest financials in end-Jun 2019, the value of the property development business held by BRC Asia’s is valued at S$28.9m.

Strong cash generation to help pare down debt

• BRC Asia’s net gearing level was 94.7% as of end-Jun 2019. We estimate that 67% (S$189.6m) of BRC Asia’s total borrowings are made up of trust receipts issued for inventory procurement (BRC Asia typically holds up to four months’ worth of inventory on hand) and floating charges for trade receivables, which has a lower interest rate of 2.0-2.5% p.a.
• The remaining loan is mainly attributable to the acquisition of Lee Metal, which comes at a higher financing cost of 4.5-5.0% p.a. BRC Asia also has a S$23.1m shareholder loan outstanding, which bears interest at a fixed rate of 4.5% p.a. and is due in Jun 2020.
• We believe that BRC Asia has the ability to pare down its debt, given its strong cash flow generation. BRC Asia generated S$69.6m of operating cash flow in 9MFY19. We forecast BRC Asia to generate FCF of S$67.4-87.9m between FY19-21F, which could help its net gearing trend down to 48.8% by end-FY21F, in our view.
• BRC Asia has a strong track record in its cash generation capability – it has managed to record positive free cash flow over the past five years (with the exception of FY18, due to merger of Lee Metal). We forecast capex requirements for BRC Asia to remain low at S$5m in FY20-22F, given the already expanded capacity post-merger.

Valuation & Recommendation

Initiate with an ADD rating and Target Price of S$1.90

• We initiate coverage on BRC Asia with an ADD rating. We like BRC Asia for its dominant position in a crucial part of Singapore’s construction industry value chain, post-acquisition of Lee Metal, which positions the company as a key beneficiary of the sector’s recovery, in our view.
• We value BRC Asia based on the Gordon Growth implied P/BV method. We assume a terminal growth rate of 0.5% and an adjusted cost of equity of 8.9%. This leads to an implied P/BV of 1.58x (versus FY19-21F average ROE of 13.7%, based on our forecasts) which translates to a target price of S$1.90, based on our CY20F BVPS.
• Our Target Price of S$1.90 translates to an implied CY21F P/E of 10.5x. Our forecast for BRC Asia’s EPS CAGR over FY18-21F is 48.5%.
• BRC Asia’s dividend yield is attractive at 3.7-4.8% for FY19-21F. We believe there is a possibility that BRC Asia will adopt a higher dividend payout ratio, given its strong cash flow generation capability of S$0.29-0.38/share between FY19-21F.
• Key re-rating catalysts include faster-than-expected margin recovery, higher dividend payout, and further announcements of infrastructure project rollouts in Singapore. Downside risks include a slowdown in Singapore’s construction demand and intensifying industry competition resulting in lower-than-expected margins.
• We believe BRC Asia should trade at a premium over other Singapore construction contractors, due to
  1. its monopolistic power of a key value chain in the construction industry, allowing it to have a diversified exposure to both the public and private sector projects, and
  2. relatively stable margin outlook compared to contractors as it does not have to aggressively try to outbid peers given its price leadership position.
  Both factors are likely to result in BRC Asia enjoying a higher sustainable ROE over its peers, in our view.

Key Risks

Dependence on Singapore’s construction demand

• BRC Asia’s business is dependent on construction demand in Singapore. The company is exposed to the cyclical nature of the construction industry in markets where it operates. A significant decline in construction demand from the public sector could adversely affect the company’s business and profitability.
• However, the impact on BRC Asia’s business is likely to lag the economic conditions, due mainly to the timing difference between the award of the construction contracts and purchase of prefabricated steel mesh by its customers. Typically, there is a lag impact of approximately 12-18 months.

Credit risk

• BRC Asia’s credit risk arises primarily from trade and other receivables. Should counterparties default on their obligations, this may have a negative impact on BRC Asia’s operations and profitability. The company has a credit policy in place, with a credit review that takes into account qualitative and quantitative factors, such as business performance and customer profile.
• As of end-FY18, BRC Asia’s top 10 customers accounted for 30% of BRC Asia’s trade receivables. All 10 customers are in the construction industry in Singapore.

Pricing competition

• In 2017, BRC Asia has a 60-70% market share by value and by volume in the prefabricated steel mesh industry in Singapore, according to Competition and Consumer Commission Singapore (CCCS). In the event that its competitors engage in aggressive pricing in order to gain market share, BRC Asia’s profitability could be adversely affected.

Fluctuations in raw material cost

• Steel accounted for 82.5% of BRC Asia’s total cost as at FY18. BRC Asia typically enters into both fixed-price and variable-price contracts with its customers. In the event that steel price increases, BRC Asia’s production costs would likely increase and, to the extent that the increase in cost is not be recovered from its customers, this could have an adverse impact on the company’s profitability.
• BRC Asia typically procures steel locally and internationally from a number of suppliers, generally working on a rolling six-month forward programme. BRC Asia normally carries sufficient stock to cover production for four months.

Foreign exchange risk

• BRC Asia’s purchases (steel bars) are mainly denominated in US$; while the company’s sales are denominated in local currency. The company also holds cash and cash equivalent in foreign currencies for working capital purposes. To minimise exposure to foreign exchange risk, BRC Asia’s group policy stipulates that all confirmed foreign exchange exposures must be hedged.

Source: CGS-CIMB Research - 15 Nov 2019