IJM is acquiring a 44.8% stake in financially distressed PESTECH (Not Rated) for RM124m cash. We are positive on the latest move by IJM that gives it an immediate presence in the rail electrification space, strengthening and widening its potential roles in impending mega rail projects. We maintain our forecasts, TP of RM1.67 and MARKET PERFORM call.

IJM is subscribing to 800m new PESTECH shares at RM124m cash or RM0.155/share, giving rise to a 44.8% stake in the Main Market-listed expert in high-voltage electrical transmission, and rail electrification and signalling. IJM is seeking from the Securities Commission a waiver of an extension to a conditional mandatory takeover offer for the remaining PESTECH shares. One of the condition precedents for the share subscription is this MGO waiver. The entire exercise is expected to be completed in 4QCY23.

PESTECH is facing operational and financial challenges arising from an escalation in material prices due to disruptions in the supply chain and geopolitics instability. Its PAT declined from RM102.7m in FY21 (FYE: Jun) to RM37.3m in FY22. It dipped to an after-tax loss of RM186.3m in 9MFY23, mainly due to a one-off loss arising from the fair value adjustment related to the disposal of its 60%-owned transmission system concession assets in Cambodia. As of Mar 2023, PESTECH has an outstanding order book of RM1.56b.

We are positive on the latest move by IJM that gives it an immediate presence in the rail electrification space. PESTECH has completed prominent projects such as the Klang Valley Double-Tracking and MRT2. It is currently working on two key projects, i.e., KLIA’s aerotrain and the Rapid Transit System between Johor Baru and Singapore. With such strategic tie-ups together with its extensive track record in the construction of railway development, IJM will be able to strengthen and widen its potential roles in impending mega rail projects such as MRT3, Penang LRT and KL-Singapore high-speed rail.

Financial impact: Assuming PESTECH is to only break even, the financing cost on the RM124m investment in PESTECH will dilute IJM’s FY25F earnings by 1.5% on a ceteris paribus basis, but will easily be compensated with a bigger role in future mega rail projects as mentioned. The RM124m capital outlay will raise IJM’s net debt and net gearing of RM2.51b and 0.26x as at end-Mar 2023 to RM2.63b and 0.27x respectively that are still highly manageable.

Forecasts: Maintained given the insignificant earnings dilution while it is pre-mature to factor in new contracts arising from its presence in rail electrification.

We maintain our SoP-driven TP of RM1.67 (see Page 2) on unchanged 13x PER valuation for its construction business, at a discount to the 16x-18x we ascribe to its peers to reflect IJM’s higher exposure in the office building segment which is weighed down by an oversupply situation. There is no adjustment to our TP based on ESG given a 3- star rating as appraised by us (see Page 4).

We continue to like IJM for: (i) the improved outlook of the construction sector with the imminent rollout of public infrastructure projects, (ii) its strong earnings visibility underpinned by an outstanding construction order book of RM5.1b, and (iii) Kuantan Port’s position as the largest port in the east coast capturing export and import activities growth.

However, we remain cautious over the restructuring of Besraya and its loss-making toll roads namely the West Coast Expressway (WCE) and Kajang-Seremban Highway (also known as Lekas) due to low traffic volumes. Maintain MARKET PERFORM.

Risks to our call include: (i) sustained weak construction job flow, (ii) project cost overruns and liabilities arising from liquidated ascertained damages (LAD), and (iii) rising cost of building materials.

Source: Kenanga Research - 25 Jul 2023