Investment Highlights

• We cut our FY20-21F net profit forecasts by 9% and 8% respectively, reduce our FV by 9% to RM1.72 (from RM1.89) and maintain our HOLD call. The earnings downgrade is to better reflect the start-up losses from the new deepwater terminal (NDWT) of Kuantan Port and West Coast Expressway (WCE). Our new FV is based on 12x revised FY20F EPS, in line with our benchmark forward PE of 11-13x for large-cap construction stocks.

• We came away from a recent visit to the company finding it hard to identify any major near-term catalyst on the horizon that could pull it out of the doldrums. Instead, IJM Corp is facing various headwinds, from both expected and unexpected sources.

• Its earnings will be weighed down by depreciation and interest expenses arising from new investments (i.e. NDWT of Kuantan Port and WCE). This is expected. What is unexpected (vs. say, six months ago) are:
  1. the increased volatility in plantation earnings of late (due to the depressed CPO prices and the rupiah’s steep depreciation against the USD);
  2. a broader-based recovery in the local property market is still nowhere in sight;
  3. the surprise outcome of the 14th general election that has cast a long shadow on IJM Corp’s construction and building material businesses (due to the cancellation and downsizing of public infrastructure projects) and toll road operations (due to the risk of them being nationalised/expropriated); and
  4. A knee-jerk slowdown in the foreign direct investment (FDI) inflow into Kuantan Port’s hinterland as foreign investors acclimatise to the altered political landscape, temporarily restraining the NDWT of Kuantan Port from realising its full potential.

• Plantation – We did not feel the eagerness on IJM’s part to dispose of its 55% stake in IJM Plantations. However, it did say that it is the duty of the board of directors to evaluate proposals being put on the table, if any. On the other hand, it acknowledged that due to the prolonged weakness in CPO prices, rising production cost coupled with the rupiah’s volatility against the USD (Indonesian plantations are typically funded with USD-denominated borrowings), unlike in the past, the plantation business no longer serves as a cushion against the cyclical earnings of other divisions such as construction and property. In fact, it has now become a source of volatility itself.
• Property – IJM Corp believes the trough of the cycle was in 2015 and 2016, and the sector has picked up slightly since 2017. This is consistent with IJM Corp’s local property sales of only RM1.4bil each in FY16 and FY17 (March), but rising to RM1.6bil in FY18. However, we believe the recovery in the local property is not broad-based but limited to the affordable segment that typically fetches sub-par margins. Against this backdrop, IJM Corp’s planned new launches are largely high-rise residential units from RM275K in the Klang Valley and from RM550K in Penang Island, 2-storey link houses from RM842K in Bandar Rimbayu and 2-storey cluster homes from RM755K in Austin Duta, Johor (Exhibit 1). IJM is confident of achieving RM1.6bil property sales in FY19F. Its unbilled property sales now stand at RM2bil.

• Construction – The earnings visibility of the unit remains good at least over the short term given its order backlogs of RM9.3bil. However, there is a downside to the value of its contracts for the MRT2 (V203 and S203 worth RM1.47bil) and LRT3 (the underground package worth RM1.1bil) as these mega projects are currently put under review by the government for cost-down initiatives. IJM Corp, like other players in the industry, is still awaiting the final decisions from the government. We agree with IJM Corp’s belief that it will emerge a winner with the introduction of a more transparent public procurement system under the new administration, as IJM Corp is accustomed to open bidding for contracts. However, we believe IJM Corp will only be able to fully capitalise on this strength during the next construction cycle (of which no one knows when that will be).

• NDWT of Kuantan Port – The RM1.5bil Phase 1 of the project will increase Kuantan Port's capacity by 13mil or 50% from 26mil to 39mil freight weight tonnes (FWT) annually. This initial phase can be divided further into Phase 1A (which is already operational, pending the official launch in Nov 2018) and Phase1B (which is still under construction, pending completion in mid-2019). We understand that the NDWT currently only caters to one customer, i.e. Alliance Steel in the Malaysia-China Kuantan Industrial Park (MCKIP). Our forecast assumes Phase 1 to break even at the EBIT level in FY19-21F, i.e. turnover could only absorb operating cost and depreciation, but not interest expense (see Exhibit 2 for more details).

• WCE – We expect the RM5.94bil greenfield toll road project spanning over 315.8km in Selangor and Perak to hit IJM Corp’s P&L (in terms of share of associate’s losses) from FY20 (a recent news article, quoting WCE Holdings, reported that the project is currently over 50% completed and five sections will open before June 2019). Similarly, our forecast assumes the toll road to only break even at the EBIT level in FY20-21F, i.e. turnover could only absorb operating cost and depreciation, but not interest expense (also see Exhibit 2 for more details).

• We remain cautious on the outlook for the local construction sector. As the government scales back on public projects, local contractors will be competing for a shrinking pool of new jobs in the market. Severe undercutting among the players will result in razor-thin margins for the successful bidders. On the other hand, the introduction of a more transparent public procurement system under the new administration should weed out rent-seekers, paving the way toward healthier competition within the local construction sector. We believe IJM is mitigated by its substantial order backlog that should keep it busy over the next 2-3 years, coupled with its proven ability to compete under an open bidding system.

• Similarly, we are also cautious on IJM’s other key businesses such as building material (due to the slowdown in the local construction sector), property (due to prolonged downturn in the local property market), plantation (due to the depressed palm oil prices) and toll road (due to the potential expropriation by the government).

Source: AmInvest Research - 25 Oct 2018