We  initiate  coverage  with  a  Buy  rating  and  TP  of  S$0.260.  XMH  enjoys  a special  position  of  being  the  exclusive  distributor  of  multiple  marine equipment brands in multiple countries. XMH was recognised by Mitsubishi as  its  largest  worldwide  distributor  for  marine  diesel  engines  for  the  lastseven consecutive years.

Riding  on  Indonesian  energy  demand  growth.  XMH  counts  half  of  the  90+ yards  on  Batam among its customers, and  with Indonesia being an  archipelagic country its demand for tugs and barges will grow in line with energy demand and GDP  growth.  Indonesia  needs  to  increase  its  oil  &  gas  production  as  well  to reduce the burden of its fuel and energy subsidies. The country's drive into offshore  oil  &  gas,  combined  with  the  Cabotage  law,  indicates  stronger  demand for small-/mid-OSVs as well.
 
$51m  in  net  cash,  $68m  market  cap.  EV/EBITDA  1.2x!  Three  quarters  of  the share price is net cash. Besides supporting the share price, this allows XMH wide latitude  in  M&A  activities,  to  embark  on  new  projects  and/or  to  increase  the dividend.  All  three  are  happening  simultaneously,  providing  upside  to estimates. Stripping out the cash, XMH is trading at a FY13F P/E of 1.7x. The EV/EBITDA of 1.2x makes XMH an ideal acquisition target, were management inclined to sell. 

Negative cash conversion cycle. XMH requires deposits from customers before placing  orders  through  to  suppliers,  and  gets  cash-on-delivery  for  its  engines. Stripping  out  excess  cash,  working  capital  is  a  negative  $7m.  Cash  conversion cycle is negative-45 days. This business generates money as it gets bigger.


Valuation: TP $0.260. DCF $0.450.  We value XMH at 5x FY13F EPS of $0.026 plus the net cash per share of $0.13, arriving at a TP of $0.260. This valuation is backed  by  a  DCF  value  of  $0.450  at  a  WACC  of  11.4%,  more  than  double  the current price. We believe it has the capacity to raise the dividend payout by 30% to 1.3'' per share, implying a yield of 7.4%.

Company Profile

57 years in engines, propulsion systems, and power generators. XMH has an extremely long track record since its 1955 beginning as a machinery repair and maintenance shop. With that  experience,  it  now  provides  engine  customisation  services  and  continues  to  repair  and maintain the engines of more than 1,000 vessels now using their products in the region.

Distribution segment sells engine packages in the 'XMH IPS' brand and power generating sets in the 'e-Gen' brand. XMH offers a value to customers by applying their know-how  to combine multiple brands of engines, propeller shafts, propellers, gearboxes, etc. into a lower-costpackage that suits the requirements for a given vessel. XMH counts about 45 of the 90 yards in Batam among their customers.

After-sales  service  segment  provides  repair  and  maintenance  services  to  vessel  owners, achieving  time-savings  for  customers  by  maintaining  a  ready  supply  of  genuine  spare  parts and accessories. With more than 1,000 vessels in Indonesia now using XMH engines, this is a segment with a ready customer pool.

Key operating driver is small-vessel marine industry in the region.  XMH's key products are  targeted  at  tugboats  and  small-/mid-OSVs.  With  the  strong  growth  in  Indonesia,  which requires tugs & barges in  large  numbers  due to its  archipelagic geography, and  the  high  oil price driving the offshore oil & gas industry, XMH is enjoying an upsurge in new orders.

Investment Summary

Rolling in the deep pile of cash. There's a fire burning in the cash-generating engine that is XMH, reaching a fever pitch in FY16F with cash on hand exceeding the entire market cap if it is not spent. Today, cash per share is $0.133 against a share price of $0.175, providing both share price support and wide operational latitude.

What can XMH do with so much cash? We see three simultaneous possibilities. First and immediately, we believe the company will raise dividends by 30% to 1.3'' per share. Second, it  can  embark  on  M&A  inorganic  growth.  Third,  it  can  invest  in  a  much  larger  facility  and expand  its  current  business  as  the  current  setup  is  already  bursting  at  the  seams.  These provide upside to earnings estimates.
 
 Riding on Indonesian energy demand growth. XMH counts half of the 90+ yards on Batam among  its  customers,  and  with Indonesia  being  an  archipelagic  country  its  demand  for  tugs and  barges  will  grow  in  line  with  energy  demand  and  GDP  growth.  Indonesia  needs  to increase its oil & gas production as well to reduce the burden of its fuel and energy subsidies. The country's drive into offshore oil & gas, combined with the Cabotage law, indicates stronger demand for small-/mid-OSVs as well.

Core  P/E of 1.7x.  EV/EBITDA 1.2x! The market is currently pricing XMH  at a nominal  6.9x FY13F EPS. Stripping out the cash, the core P/E is a mere 1.7x. The immense cash pile also means that the EV/EBITDA is an extremely low 1.2x, such that XMH would actually be a no-brainer acquisition target were the management inclined to sell.

DCF value of $0.450. XMH is a cash business, thus the DCF is a natural valuation tool. The results are stunning, even with sharply depressed assumptions. Beyond FY14F, we assume 5% growth to FY20F, a second-stage growth of 2% to FY25F, and a terminal growth rate of 1%.  WACC  is  11.4%  which  includes  a  2%  small-cap  penalty.  Inverting  the  argument,  the market is pricing XMH as though growth  was  0%  beyond FY13F, and the WACC was  65%. The absurdity of today's price becomes apparent.

Cash conversion cycle of negative-45 days. XMH requires deposits from customers before placing  orders  through  to  suppliers,  and  gets  cash-on-delivery  for  its  engines.  Cash conversion  cycle  is  negative-45  days.  It  has  a  working-capital  position  of  negative-$7m, which highlights extremely efficient use of capital.

Very  strong  $10m  annual  free  cash  flow.  A  negative  cash-conversion-cycle  business actually  accumulates  more  cash  as  it  grows  bigger,  unlike  other  companies  with  working capital  requirements.  With  this  in  mind,  we  have  been  extremely  conservative  with  growth assumptions. With our 5% revenue growth assumption, XMH can generate $10m per year in free cash flow in each of the next three years, which is a staggering 60%  total growth of the cash pile today.

Forecast  7.4%  yield.  Paid  to  wait.  With  such  strong  cash  generation  capability  and  a massive cash hoard, we think that XMH can easily raise its dividend to  1.3'' (equivalent to a 50% payout ratio) translating into a 7.4% yield. At the very minimum, it can easily sustain the current 1'' dividend indefinitely. This is a stock that pays investors to wait for the full value of its cash, whether in special distributions, new investments, or M&A, to be realised.

TP of $0.260.  Sense-check still makes sense. Our  TP of $0.260  is based  on  a SOTP: 5x FY13F EPS of $0.026 plus the net cash of $0.13. Our TP implies a forward P/E of 10x, P/B of 2.1x,  EV/EBITDA  of  only  3.6x,  and  a  dividend  yield  of  5.0%.  None  of  these  valuations  is exceptionally high, and still looks attractive from the EV/EBITDA and dividend yield metrics.

Earnings Outlook

Targeting steady growth. XMH has been on a gradual growth path since 2008, with PATMI growing at a CAGR of 17% from S$5m in FY08 to $9.5m in FY12. The large spike in FY10 was  due  to  the  shipbuilding  boom  in  the  preceding  years  producing  very  favourably-priced contracts ' margins spiked to 28% from 20% in preceding years. We are forecasting gradual growth in the bottom line to $10m/$11m in FY13F/14F.

We  note  that  FY12  earnings  were  boosted  by  a  $4m  gain  from  forfeiting  a customer's deposit, else earnings would have troughed out along with revenue. FY13F earnings should be higher-quality in nature. Margins have also stabilised, following the GFC fluctuations. XMH enjoyed healthy gross/net margins of 25%/15% in FY12.

Topline  recovered  three  quarters  ago.  XMH  saw  a  revenue  recovery  in  Q3  of  FY12, though  full-year  figures  were  dragged  down  by  the  weak  first  half.  Already,  in  the  1Q13  the top line of $21.9m is already 35% of FY12's entire revenue.

We like companies praised by both suppliers and customers. XMH has been recognised by its main supplier, Mitsubishi, as its largest worldwide distributor for marine diesel engines for seven consecutive years since 2005. XMH has been a key distributor for Mitsubishi for 17 years.  It  also  enjoys  a  strong  customer  base  with  repeat  sales  averaging  70%  in  the  last three  years.  These  are  important  factors  we  like  to  see  as  these  business  relationships  will help to maintain the company's performance going forward.

Benefits  of  business  relationships  evident  in  unique  business  model.  Most  distributors are likely  to enjoy exclusive distributorships from just one  principal  and the exclusivity tends to be restricted to a single territory. Some of the more successful ones enjoy a single brand with  exclusive  rights  in  multiple  territories.  XMH  has  become  one  of  the  most  successful, enjoying exclusive distributorships with multiple highly-regarded names in multiple territories.

Cash upfront, cash on delivery. Very low inventory risk. Cash is the lifeblood of business, and XMH has a business model that keeps it in fighting-fit condition at all times. It requires a deposit  from  customers  at  contract-signing,  and  requires  full  payment  before  it  delivers  the final product to the shipyard.

Unlike other distributors that bear steel/equipment price risks, XMH does not keep inventory ready-for-sale. Its entire Distribution-related inventory  is backed by firm orders with deposits and credit terms from suppliers, while the After-Sales segment only requires some $4m (out of current $28.8m) of inventory. This shows up in the hard numbers ' XMH's cash conversion cycle is consistently negative, with suppliers fully funding the entire business.

Of  note:  FY12  CCC-component  numbers  deviate  from  historical  averages  due  to  a  large contract still on hand at the 30-Apr cut-off date. As of 1Q13, respective days are 24/167/253 for a cash conversion cycle of negative-61 days, i.e., back to normal.

How many businesses have core ROA of 21%? Even with a forecast $50m of cash at end-FY13F, XMH will still generate strong returns at 22% ROE and 11% ROA. Stripping out cash excess  of  $4m for  working  capital,  ROE  becomes  a  (rather  meaningless)  613%,  while  ROA would be a strong 21% which we see as the core return rate on this business.

Valuation: Initiate with BUY, TP of $0.260 backed by DCF value $0.450

How  do  you  value  a  company  that  is  75%  cash?  By  valuing  the  core  operations  and adding on the net cash value. We value the core operations at 5x FY13F EPS. We select this multiple for a number of reasons: i) The very small size of the company precludes most fund investment (Note that we flag this as a market factor. We are emphatically saying that small size  in  this  case  does not equate to higher risk due to XMH's very strong cash generation ability); ii) Stable growth, not a strong-growth company like Nam Cheong or AusGroup which we value around 8x to 10x in this market environment; iii) The riskiness of accounting profits due to exchange-rate fluctuations.

Our TP of $0.260 is derived from 5x FY13F EPS of 2.6'' plus 13.3'' in net cash. Including the 1.3'' of dividends we expect this year, total upside is 58%.

DCF value of $0.450. XMH is a cash business, thus the DCF is a natural valuation tool. The results are stunning, even with sharply depressed assumptions. Beyond FY14F, we assume 5% growth to FY20F, a second-stage growth of 2% to FY25F, and a terminal growth rate of 1%. WACC is 11.4% which includes a 2% small-cap penalty

Inverting the argument, the market is pricing XMH as though growth was 0% beyond FY13F, and the WACC was 65%. The absurdity of today's price becomes apparent.

Sense-check  still  makes  sense.  Our  TP  implies  a  forward  P/E  of  10x,  P/B  of  2.1x, EV/EBITDA  of  only  3.6x,  and  a  dividend  yield  of  5.0%.  None  of  these  valuations  is exceptionally high, and still looks attractive from the EV/EBITDA and dividend yield metrics.

Industry: Indonesia marine market enjoying tailwinds

Indonesia is the world's 4th largest  country  by  population.  It  is  an  archipelago  of  17,508 islands, of which about  6,000 are inhabited. It is Southeast Asia's largest economy and is a member  of  the  G-20.  The  archipelagic  nature  of  the  country  makes  tugs  and  barges  the lifeblood of the transportation sector, barging being to Indonesia what trucking is to the USA. Most of the oil and gas resources and reserves are found offshore, too.

Demographics  paying  a  dividend.  The  most  fundamental  driver  of  energy  demand  in Indonesia  is  the  population,  growing  both  in  numbers  and  in  wealth.  Indonesia  is  currently enjoying what sociologists call the 'demographic dividend', where the working age group comprises  the  bulk  of  the  population  with  67%  of  the  population  and  a  median  age  of  only 28.5 years.

Indonesia  is  the  most  stable  growth  economy  in  SEA.  Really.  Meanwhile,  the unemployment rate has fallen from its peak of 11.2% in 2005 to about 6.4% today, driving a strong growth in GDP. Indonesia was one of the few countries that did not suffer a recession in 2009, with growth merely slowing to 4.6%, bouncing back to 6.2% in 2010. Indonesia has delivered 4.5% to 6.5% growth per year annually for the last decade, marking it as the most stable growing economy in Southeast Asia.

Economy, and energy consumption, taking off. Indonesia is clearly in the 'take-off' stage of development where per-capita incomes surge, which will add a further spur to the rising oil consumption  and  electricity  demand.  These  demographic  and  economic  trends  are  the driving force behind the energy sector ' coal and oil & gas.

Coal: Surging electricity demands driving tugs & barges market

Market leader in thermal coal. Indonesia is the world's primary exporter of thermal coal, and is  second  only  to  Australia  in  the  higher-grade  metallurgical  coals.  Indonesian  coal  tends  to be  of  low-to-medium  calorific  values,  but  is  distinguished  by  their  low  ash  and  low  sulphur content.  Domestic  consumption  demand  is  driven  by  the  steadily  growing  population.  The rapid increase in purchasing power is driving electricity demand, the supply of which is mostly derived from coal-fired power plants.

Rising  population  and  wealth  demand  electricity.  Indonesia's  state-owned  power  generation company, PT PLN, operated more than 5,000 power plants in Indonesia in 2010, of  which  more  than  4,500  are  small  diesel  plants  outside  Java.  Of  the  roughly  500  large power  plants,  there  are  17,000MW  of  coal-based  generation  capacity,  7,911MW  of  gas turbines, and the remainder 8,870MW are generated from geothermal and hydro power.

The  rate  of  electricity  generation  capacity  growth  has  spiked  in  recent  years,  as  the government embarked on two 10,000MW plans to build power plants and to open the market to  independent  power  providers.  A  large  part  of  this  new  capacity  is  coming  online  today, helping to support the tugs & barges charter rates.

 47%  more  coal-fired  capacity  proposed.  With  fuel  subsidies  hurting  the  Budget,  the Indonesian  Government  is  keen  to  steer  growth  in  electricity  generation  away  from  oil/gas-fired plants towards cheap locally-available coal. The 15,921MW total of proposed generation capacity  is  a  very  large  47%  increase  over  the  current  total  capacity,  and  we  expect  this growth to be realised over the next decade.

Strong  demand  for  tugs  &  barges  in  Indonesia. With the  Cabotage  Principle  now  strictly enforced, Indonesia's tug & barge market is enjoying higher-than-regional charter rates. With the positive backdrop of improving wealth, greater electricity consumption, and the immutable distances  between  the  islands  producing  and  consuming  coal,  this  is  a  market  that  will continue to enjoy respectable growth. The main shipbuilding centre of Indonesia is in Batam, and of the 90+  yards in operation there, 45 are customers of XMH. XMH's exclusive distributorships of multiple brands yield for it a strong business position in Batam.

Oil & Gas: Government stimulating offshore production

Falling  oil  production  and  reserves.  Indonesia  used  to  be  a  member  of  the  OPEC,  until 2008/09  when  it  became  clear  that  after  six  years  of  net  imports  it  was  time  to throw  in  the towel.  The  key  reason  was  underinvestment  '  oil  reserves  have  been  on  a  one-way downtrend  since  1980  when  data  were  first  available.  The  surge  to  peak  production  in  the three years to 1991 was not accompanied by commensurate exploration, causing reserves to remain  low.  Today,  reserves  are  near  a  record  low  at  only  4.04b  barrels  (lowest  on  record was 3.75b bbl in 2008), and 2011 production was a 30-year low of 942kbpd. 

Oil subsidies breaking the Budget, hitting poverty-alleviation programs. Indonesia has a fuel-price subsidy program, which has in recent years become simply unaffordable. Not only are  net  import  volumes  increasing  (now  up  to  a  record  489,000  bpd  in  2011),  the  sharply elevated global oil price is compounding the dollar cost of this program. Fuel subsidies were Budgeted  at  IDR  137.4  trillion  (US$14.5b),  equivalent  to  9.6%  of  total  Government expenditure, but this number has been revised to IDR 216.8 trillion (US$22.8b), just over 15% of the entire Budget.

Likewise, electricity subsidy spending is being revised from IDR 65 trillion to IDR 89.1 trillion(US$9.4b). Together, energy subsidies are consuming 21.3% of the Budget. To maintain thdeficit  below  the  legal  limit  of  3%  of  GDP,  the  Government  may  have  to  scale  back  otheprograms,  including  those  targeted  at  poverty  alleviation.  As  such,  the  failure  to  generatsufficient oil export revenues has a direct social impact.

Gas  exports  soaring,  providing  much-needed  relief.  The  other  half  of  this  oil  &  gas industry  in  Indonesia  is  a  clear  success  story.  From  negligible  volumes  in  1975,  Indonesia produced 75.6 billion cubic metres (bcm) of natural gas, and exported 37.7bcm in 2011, the bulk of it to Japan, South Korea, and Singapore.

Better  prospects  in  gas.  Indonesia  has  had  more  luck  with  finding  gas  than  oil.  Though production  rates  grown  steadily  (1.8%  CAGR  over  the  last  10  years,  to  75.6bcm  last  year), new gas discoveries have allowed reserves to continue growing albeit at a marginally slower rate (1.3% CAGR over the last decade, ending 2011 at 3.0Tcm).

Government pushing for higher offshore oil & gas investment.  To avoid  the social pain of  scaling  back  on  poverty-alleviation  programs,  the  Government  is  stimulating  the  offshore oil & gas industry. As much of Indonesia's exploration & production activity is happening in shallow  waters,  the  majority  of  the  vessels  required  fall  into  the  small-/mid-sized  OSV category. XMH provides the high-speed engines that are used in these vessels, and thus it is enjoying the up-cycle in this market today.

Key Risks

Exchange rate risk the key accounting-profits risk. But unrealised. The key swing factor in accounting profits is actually the exchange rate. XMH sells a lot of Mitsubishi engines, and as such, keeps a large balance of JPY on both sides of the balance sheet. Being fully-funded by suppliers, a strong JPY increases the weight of payables and produces an accounting loss when converted to the reporting currency in SGD. However, these are unrealised losses, and may be reversed in subsequent periods.

Main  supplier Mitsubishi  accounts  for  70%  of  sales.  There  is  supplier  concentration  risk given the high weighting Mitsubishi has in XMH's sales. While there is no guarantee of the continuation of the distribution agreement, we believe Mitsubishi will not terminate its largest worldwide distributor without due cause. Further, the main centre of shipbuilding in SouthEast Asia is in Batam with over 90 yards, and XMH has an exclusive distributorship for Mitsubishi (and many other brands) in the entire Indonesia.

Dependent on regional small-vessel marine industry. About  80% of XMH's engine sales are in small high-/medium-speed engines used in tugboats and small-/mid OSVs. As such, its performance is dependent on this market. Fortunately, there is support in the strong growth in Indonesia  which  requires  tugs  &  barges  due  to  its  archipelagic  geography,  and  the  high  oil price is sustaining the offshore oil & gas industry which in turn boosts OSV demand.

Site  visit  photos.  We visited XMH's facility at Sungei Kadut Avenue, and saw a very neat warehouse  for  the  After-sales  service  inventory,  and  some  four  dozen  marine  engines  / generators very neatly stacked near the testing workshop. The facility was rather full, though not yet bursting.

Source: OSK