The search for hidden gem in the local bourse has never been an easy task. STRAITS stands out on our investment radar when the company announced its intention to diversify into the telecommunication business.

Following our recent engagement with the management, we are convinced that telecommunication segment will be a significant growth driver for the group in the future. We expect the earnings potential to be huge, evidenced by the group’s ability to secure an orderbook of c.RM160mn. Meanwhile, the group’s core oil bunkering business is a beneficiary of the escalation in the Red Sea crisis and should remain stable in coming years. We value STRAITS at RM0.20/share, based on SOP valuation (Not Rated). We believe our valuation is fair considering the growth potential of its telecommunication segment in line with 4G/5G rollout and the increasing adoption of digitalisation across various industries.

About Straits Energy Resources Bhd

Straits Energy Resources Bhd (STRAITS) is an investment holding company principally involved in 5 business segments, namely (i) oil bunkering and shipping related services, (ii) telecommunication and network services, (iii) inland transportation services, (iv) port management and facility management, and (v) shipto-ship (STS) operation. Oil bunkering is the core business of the group, accounting for 99.2% of the group’s revenue in FY22 (Figure 1). STRAITS mainly operates in Malaysia (>99% of FY22 revenue).

Diversification Into Telecommunication and Network Services

In March 2023, STRAITS’ shareholders have approved the group’s proposal to diversity into telecommunication and network services business. The main reason for the proposed diversification is because of the low margin from existing oil bunkering business (PBT margin of 0.6%-0.9% in FY21-FY22).

STRAITS’ telecommunication segment involves the provision of end-to-end solutions in telecommunication, from infrastructure, networking, maintenance, software, hardware and related services to organisations. The segment is an asset light business as the group will mainly come up with the solutions and engage with contractors if necessary. Essentially, the segment can provide solutions to meet emerging needs for communication and Internet of Things system for buildings, campuses, ports and industrial parks.

For instance, STRAITS recently secured a RM15.2mn subcontract to install, test, and commission the underground cables and accessories for Tenaga Nasional Berhad. Other projects the group secured include a RM40.7mn subcontract to implement building works, electrical works, ICT works and smart building system for Pusat Perubatan Universiti Kebangsaan Malaysia (PPUKM). We expect the segment to grow exponentially from FY24 onwards, leveraging on the rollout of 4G/5G nationwide and the increasing adoption of digitalisalisation.

Experienced Leadership Minimising Execution Risk

In the event of diversification, the main concern of investors would be the execution risk. Even the best companies may stumble due to lack of experience when venturing into a new business. Fortunately, STRAITS has appointed Mr. Sunny Ho Khin Choy, a veteran with thirty years of experience in the telecommunication and digital transformation space to lead the group’s telecommunication arm. Sunny’s last posting before this was in Digital Nasional Berhad (DNB). Before his stint at DNB, he had led numerous key sections in Axiata Group Bhd, Edotco Group Sdn Bhd, Nokia Malaysia and Ascom. Sunny’s many years in the industry significantly reduces the execution risk of STRAITS. In fact, STRAITS currently has an orderbook of c.RM160mn, a testament of the confidence in the group’s ability to deliver. This is a significant growth from RM2.6mn the group secured during its first year of operations in FY22.

Potential Expansion Into AI Powered Data Centres

According to management, STRAITS is looking at expanding into data centres powered by artificial intelligence (AI). The group is talking to a potential partner whereby STRAITS will provide the IT solution for the data centres. Data centre storage capacity is expected to grow from 10.1 zettabytes (ZB) in 2023 to 21.0 ZB in 2027 for a five-year compound annual growth rate (CAGR) of 18.5%. As AI continues to gain widespread adoption, the growth potential for STRAITS’ telecommunication segment, particularly in the AI powered data centre is huge, in our opinion.

Beneficiary of Red Sea Crisis

Oil bunkering is a low margin business and the profitability mainly pivots on the volume of fuels sold. Following the escalation of tension in the Red Sea, many shipping firms have begun avoiding the Red Sea and instead opt for a lengthy detour around the Horn of Africa, adding around 6,500km or 10-14 days of sailing time to each trip. This, according to some estimates, requires an additional USD1mn or c.RM4.8mn worth of extra fuel for a round trip between Asia and Northern Europe. According to the Maritime & Port Authority of Singapore, the overall sales of marine fuel in Singapore surged 12% YoY in Jan 2024. The higher demand for marine fuel bodes well for the profitability of STRAITS’ oil bunkering segment.

Listing of Oil Bunkering and Shipping Related Services

In October 2023, STRAITS announced the group’s intention to list its oil bunkering and shipping related services segment on the NASDAQ stock exchange. As part of the proposed listing, the group intends to reorganise some of its subsidiaries and form a separate listing group suitable for the listing on NASDAQ. The listing enables partial monetisation of STRAITS’ bunkering business and allows the group to finance for the growth of its telecommunication segment. We believe that the group may eventually exit the oil bunkering business once telecommunication segment stabilises and contributes more to the group’s bottom-line. Once this materialises, STRAITS could fetch a better valuation as it would be rerated as a pure telecommunication solutions provider.

Forecast

Stripping off exceptional items including foreign exchange gains, we project that the group to register a core loss of RM1.2mn in FY23. However, we expect the group to turnaround to a core profit of RM16.3mn in FY24 and RM20.1mn (+23.4% YoY) in FY25 respectively, mainly driven by earnings growth in the telecommunication segment on the back of robust orderbook of c.RM160mn and orderbook replenishment assumptions of RM200mn per annum for both FY24 and FY25 recognised over 3 years (average project tenure is 1-3 years) (Figure 3, 4, 5, 6). For the telecommunication segment, we assume a PBT margin of 5%/12%/13% for FY23/FY24/FY25 respectively. Meanwhile, we expect oil bunkering business to remain steady but will unlikely contribute significantly to the group’s bottom-line growth moving forward.

Valuation

We value STRAITS at RM0.20/share, based on SOP valuation (Figure 7). There is no direct peer for STRAITS listed on the local bourse. We assign a target PE multiple of 5x for the oil bunkering segment in view of its stable earnings contribution despite the thin profit margin and relatively limited growth potential. As for the telecommunication and network services segment, we assign a target PE multiple of 15x, which is a discount of 15% from peer average of around 18x (Figure 9). We believe our valuation is fair considering the growth potential of its telecommunication segment in line with 4G/5G rollout and the increasing adoption of digitalisation across various industries. Not rated.

Source: TA Research - 20 Feb 2024