CSE Global – 4Q FY2011 Profit Guidance

Truly, the market has time and again proved the importance of having a margin of safety. Investors following CSE Global will have known about its profit guidance announcement on 6 Feb. Not much information has been disclosed yet from CSE and we will have to wait till its result briefing sometime late Feb.

But first, some thoughts from my side.

In its profit guidance, this was what CSE Global has announced:

“The Board of Directors of CSE Global Limited (“CSE”) wishes to announce that CSE is expected to report a profit which is less than advised in our November 2011 Results Announcement in which it was stated that,

“CSE is confident that despite the turbulent world economic situation its 4Q2011 performance will be better than 3Q2011 and 4Q2010”.

In Q4 2011 CSE has been adversely affected by the fact that several of our customers were late in providing approval for our engineering designs which has led to a lower than planned lower revenue and profit contribution from those contracts.

Full details will be disclosed when the Company announces its financial results for the full year 2011 on or before 28 February 2012, but the guidance is that the Board anticipates that the Q4 profit after tax will be around 75% of the profit after tax achieved in Q3 2011.”

Such profit guidance then cause a sharp plunge in its share price, selling at a low of $0.775 before closing at $0.845. There is not much to speculate but here are some of my opinions:

1. It is more important to determine whether the “late customers” were merely late or have cancelled their orders. In the case of the former, it only mean a shifted revenue recognition to FY2012. If it’s the latter, then we need to re-evaluate CSE prospect. I suspect it’s likely to be the former since given current still-unstable global conditions coupled with a contradicted surge in oil prices, it is very reasonable for O&G customers to hesitate in their project timeline. Moreover, CSE is providing a downstream service for its offshore O&G customer. The same reasoning (about uncertain global condition) goes the same for its other sectors as well. (E.g. UK may hesitate in healthcare roll-out given Europe’s condition)
2. We need to determine how much more contracts have been won. If there is a substantial amount added to its already record-high contract wins, then I believe the momentum should be set on the right track
3. This is not the first time CSE has disappointed. Ever since its project overrun in 2Q FY11, they have been assuring better and more optimistic result each quarter but has yet to delivered one that is remarkable. No doubt, the management is capable but could there be a possibility of management faking confidence in order to maintain its reputation?
4. Lastly, there has been concern about the effect of Mr Tan Mok Koon’s sabbatical leave on CSE management performance. I think that is an overplay of one’s fear. CSE builds on a pretty long track record and I don’t think it can be determined by one man’s performance. Moreover, the intention of his sabbatical leave was made known one year ago and I believe the market has discounted it well enough.

Overall, I believe the utmost importance is to determine which proportion of customers fell into the “late approval” category, possibly any reasons for it and whether will the revenue recognition be delayed or cancelled altogether.

I did a quick forecast based on its 75% guidance and CSE should be forecast to earn $27.7m in FY2011 – nearly 50% drop from FY2010. Applying 3Q FY2011 proportion of minority interest and a historical average of 15x, this should provide a support price level of $0.805. Though the price fall has wiped a substantial portion of my paper profit, I remain convicted of CSE’s fundamental and may proceed to buy more if prices prove to be attractive again.

Lastly, this incident again reminded me of the importance of always applying a margin of safety in my investment. It’s only with a decent margin of safety applied that it will ensure a minimal capital loss at such abrupt and unpredictable situation.

I’ve requested to attend the analyst briefing end Feb and will provide updates if possible.