Growth in profits albeit a decline in margins. Gross profits were reported to increase from RMB 47.0 million in 2QFY2008 to RMB 56.6 million in 2QFY2009 depicting a 20.5% growth. Despite earnings growth, the Group’s gross profit margin fell by –5.2ppts from 45.0% in 2QFY2008 to 39.8% in 2QFY2009. The decline in profit margins was brought about by sales of equipment to the telecommunications operators. The telecommunication operators have, in 2008, changed their procurement policy to one that encourages central bulk purchasing for certain contracts based on their overall or provincial requirement. Contracts of such nature command lower margins, as there are no other services such as design and installation services required. The Group’s net profits for 2QFY2009 and 1HFY2009 increased by RMB 5.4 million or 15.0% and RMB 9.8 million or 16.1% compared to the corresponding periods in 2008. Net profit margins fell from 34.6% in 2QFY2008 to 29.25% in 2QFY2009. Net profit margins for 1HFY2008 was 33.3%, falling to 29.5% in 1HFY2009. The fall in net margins were due mainly to significantly higher general and administrative expenses as well as a moderate increase in finance costs due to increased borrowings.
The road ahead. We still believe that Sinotel, amidst this frenzy of telecommunication operators’ capital expenditure spending, is well positioned to benefit considerably. Despite the economic slowdown, China’s telecommunication industry has proven its resilience through progressive growth due mainly to the introduction of 3G this year. We believe that a few factors will seek to ensure the industry will continue to perform well: The number of cities targeted to have 3G networks for this year alone (more than 200 key cities) and massive upgrading projects running concurrently across the country to handle increased subscriber base. These all require significant capital expenditures by the (3) three telecommunication operators, benefiting equipment/solutions providers like Sinotel.
The Ministry of Industry and Information Technology (“MIIT”) in the PRC has expressed the Chinese Government’s intention to spend close to RMB 280 billion on 3G upgrading networks in the next three (3) years, inclusive of the RMB 150 billion to be spent in 2009. To date, the three (3) telecommunication operators have spent more than RMB 80 billion collectively, which is in-line with MIIT’s estimation done at the beginning of the year.
Reiterate BUY rating at a revised fair value estimate of S$0.33. We maintain our BUY rating with a revised fair value estimate of $0.33, from a peg of 3.5x to FY2009’s earnings. We have also increased our revenue forecasts for FY2009 and FY2010 slightly, taking into consideration the recent contract wins. Our previous price target of S$0.27, pegged to a 3.0x FY2009 PE, has been achieved and we believe, with the bullish sentiments for China’s telecommunication industry for the next few years, Sinotel, as one of the major beneficiaries, should see further contributions to its revenues as seen in the number of projects clinched in the last few months. A quick look at its immediate peers (Exhibit 2), we can see that Sinotel is already trading at a significantly lower PE value as compared to the rest with the average trailing PE for its peers at 16.61x and forward PE of 11.39x. Average peer price to book value is at 1.39x whilst Sinotel sits at 0.93x.
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