Forex losses will drag earnings down in 3Q09. Tat Hong Holdings Ltd (Tat Hong) has warned of lower profits for its 3QFY09 results due 13 Feb 09. In its profit guidance, management highlighted two key areas of weaknesses that will drag the group's performance down: forex losses - realised and unrealised - as well as weak equipment sales. Forex losses stemmed from the strengthening of the Japanese Yen (JPY) against the Singapore Dollar (SGD) and Australian Dollar (AUD). As the group imports most of its equipment from Japan, the continued strengthening of the Yen will result in forex losses and lower inventory levels. Exhibit 1 illustrates the movements of the SGD and AUD against the Yen in 3Q09. The AUD swung by approximately 39% from peak to trough, while the SGD fluctuated by around 20% against the Yen. We estimate that Tat Hong could incur ~SGD5m of forex losses for every JPY1b of inventory purchased during the quarter.

Equipment sales weakened by credit crunch. Weak equipment sales will weigh on the group's earnings. This comes as no surprise and has already been factored into our assumptions. The global economic slump has curbed capital expenditure among industry players, while the credit crunch has restricted the availability of loans to many of Tat Hong's customers, resulting in slumping equipment sales. Nevertheless, we believe that the group's stable rental income will partially mitigate the impact of weakening equipment sales on its overall earnings. Tat Hong's business model has transited from equipment sales to equipment rental with rental income accounting for over 66% of the group's gross profit. Rental income is expected to stabilise the group's long term earnings in difficult times like these.

Beware of earnings downgrades; reduce to HOLD. We have lowered our FY09 earnings estimate by 6% to account for forex losses, bringing our forecast to S$85.2m (from S$90.6m), which is below consensus. However Tat Hong could still miss our estimates, depending on the severity of forex losses, which will only be made known during the release of its results. Tat Hong's shares have risen by 16% since our last report and are trading close to our S$0.75 fair value estimate. This, coupled with the prospect of further earnings downgrades after the release of its results, leads us to downgrade our rating to HOLD.