Cost-plus vs. back-to-back. Midas signs two types of contracts with its customers. For back-to-back contracts, Midas locks the prices of raw materials in after securing the contract thus profit margins are protected. However, these contracts come with a premium which is required by the aluminium suppliers. Cost-plus approaches profitability in absolute terms where Midas marks up its profits with an absolute amount instead of a margin. As aluminium prices remain low, either contract types could lead to lower absolute dollars for Midas, translating to a lower topline but possibly better margins.
Competition? Recently, China Zhongwang Holdings (Zhongwang) was listed in the Hong Kong and have garnered a significant amount of interest, raising US$1.26b (world's largest IPO YTD). Although the Zhongwang had indicated that it has been engaged in the rail industry, we understand that it currently has a lower grading certification from only one of the three major train manufacturers which it obtained in end 2008. Midas has indicated that it has not encountered Zhongwang in their past bids for projects in a significant way. As such, we think that Zhongwang is positioning to enter the rail industry but currently does not pose a significant challenge to Midas at this juncture. However, we acknowledge Zhongwang's significantly stronger balance sheet and do not discount a faster-than-anticipated penetration into the market.
Downgrade to HOLD on valuation. Despite higher margins, the net effect of low ASPs edges our estimates downwards. However, we are rolling our valuation forward to FY09/10F (prev: FY09F) with a similar peg of 12x and our fair value is now S$0.64 (prev. S$0.63). With its aggressive share price run up, we are downgrading Midas to a HOLD. 2010 will see earnings kicker from its 3rd line, bigger and better margined NPRT contributions and margin enhancers from its complementary downstream activities.
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