· Diversified earnings base. Fitters Diversified Berhad (FITTERS) is a onestop fire protection specialist that manufactures, trades and specialized in fire-fighting protection products. After being listed in the main board in 2007, the company has diversified its business by venturing into property development, renewable energy (RE) and most recently, PVC-O pipes manufacturing via 65.0% partnership with Molecor Technologia (10.0%) and Rickwil Malaysia (25.0%). Currently, all three operating segments are contributing equally to the topline. Interestingly, the new segment could significantly contribute to the group’s bottomline as FITTERS has the exclusive rights for 3 years (expiry: 2016) from 27 Nov 2013 to manufacture and distribute the pipes in the Southeast Asia region.

· Pipe Manufacturing is the next growth engine. We believe this recentlyestablished division will be the major earnings driver going forward underpinned by (i) 8 years tax break granted by the East Coast Economic Region and Malaysian Investment Development Authority, (ii) FITTERS has already achieved its internal target of 10.0% for FY15, signifying strong demand for this product. Going forward, the company plans to double its plant capacity to 22kMT/year by adding 3 extra production lines in mid-2015. We are positive on this expansion plan as FITTERS could (i) reap the pipe replacement market in Malaysia and Southeast Asia, and (ii) participate in non-revenue water (NRW) reduction programme in Malaysia.

· Brighter earnings outlook in FY15 from high property unbilled sales… Property division is expected to improve in the near term driven by the recognition of 85.0% of unbilled sales (RM128.7m) this year. Furthermore, two new projects will be launched by this year: (i) redevelopment of Plaza Pekeliling into high-end SOHO and suites (GDV: RM140.0m), and (ii) midend residential project in Rawang (GDV: RM380.0m). Despite a slow property market, we anticipate considerable take-ups for the projects as Plaza Pekeliling sits on the prime Jalan Tun Razak while demand for affordable housing or township driven products remains healthy.

· …and expectations that RE will return to black. Management believes the worst is over for the RE division as it came clean post restructuring, backed by development of 3-4 biogas plants, including a 2MW biogas plant at its own mill in Kedah. Hence, RE is likely to breakeven although stronger profitability will likely take some time. Potential upside could come from any concrete joint development of biomass gasification plants with the Sabah government that is in progress now. We also understand that FITTERS plans to list this division in Singapore. Should this listing happens, it would unlock this division’s value; we reckon this will not happen so quickly or until the RE division becomes more profitable.

· FY14 earnings down by 14.8%. FITTERS’ FY14 core net profit declined by 14.8% to RM33.0m primarily due to (i) weaker property earnings given the tail-end contributions from ZetaPark@Setapak which has been completed, (ii) losses in RE division as a result of sharp drop in FFB input caused by the dry season.

· Projecting FY15E core earnings of RM36.6m (+10.9% YoY). We have assumed some margin compressions for fire services, resulting in declining earnings contributions for the segment by 20.0%. Positively, this is more than negated by its other segments. The main profit driver will be from its pipes manufacturing division, particularly given the 8-year tax break. RE is expected to be back in the black this year (from losses in previous years) and we are conservatively assuming very marginal profits. Property contributions will be flattish as we expect the main drivers to come mainly from their unbilled sales while we have pushed new launches towards year end due to the challenging property landscape.

· NOT RATED with FV of RM0.72, based on SOP valuations, implying FY15E core PER of 8.9x or above its historical mean of 7.1x (peak: 13.6x). However, it is slightly below the FBMSCAP Fwd PER of 10.0x. We admit that our earnings projection is conservative because the group is at the beginning of a new growth phase. Hence, we prefer to remain cautiously optimistic, i.e. we would like to see more consistent earnings delivery from its pipes division and no further weaknesses from fire services/RE segments to determine if the stock warrants a higher earnings projection and valuation basis.

Source: Kenanga Research - 14 Apr 2015