Investment Highlights

• We maintain our UNDERWEIGHT call, forecasts and FV of RM2.20 based on 10x CY19F FD EPS of 22.0 sen, in line with our benchmark forward target P/E of 10x for largecap construction stocks.

• Gamuda's 1HFY19 net profit came in at 64% and 55% of our full-year forecast and the full-year consensus estimates respectively. We consider the results within our forecast but below market expectations as we expect a weaker 2HFY19 with a downsized MRT2 project.

• Its 1HFY19 net profit declined 19% YoY due to weaker performance from all divisions, i.e. construction (weaker margins due to the downsized MRT2 contract), property (weaker margins as well from new township projects) and concessions (absence of contribution from Splash post its disposal).

• Gamuda remains hopeful that the government’s takeover of its stable of toll roads will be carried out on a “willing buyer, willing seller” basis. It believes the valuations will be DCF-based and that the government is unlikely to invoke the expropriation clause. It holds the view that a deal is likely to be concluded by “mid-2019”. We value Gamuda’s toll roads (based on its effective stakes) at RM1.9bil to RM2.3bil (Exhibit 2).

• Gamuda sees “stronger new project flows” in 2H2019, “with further improvement in 2020”, citing “catalytic projects” such as East Coast Rail Link, Klang Valley Double Track, Johor Bahru-Singapore Rapid Transit System, Pan Borneo Sabah Highway, MRT3 and Penang Transport Master Plan. We see tremendous disconnect between Gamuda’s expectations and the reality of the government’s finances at present.

• Gamuda recorded RM1.3bil property sales in 1HFY19, with overseas projects (largely in Vietnam) contributing about 65%, while local projects accounting for the balance 35%. Nonetheless, Gamuda remains confident that it will meet its FY19F property sales target of RM4bil, with local and overseas projects contributing RM2.3bil (56%) and RM1.7bil (44%) respectively. Gamuda is bullish on Vietnam as well as its new township projects in the Klang Valley, i.e. Gamuda Gardens (near Rawang), Gamuda Cove (near Nilai) and twentyfive.7 (near Kota Kamuning). At present, Gamuda’s unbilled sales stand at RM2.2bil, easing slightly from RM2.3bil three months ago.

• We maintain our view that the current slowdown in the local construction industry sector is no ordinary sector cyclical downturn, but a secular change to the sector’s fundamentals, triggered by: (1) A major cutback in public infrastructure spending over the medium term as the government adheres to fiscal prudence; and (2) The permanent reduction in overall margins for players in the absence of high-margin directly-negotiated government jobs, as the government observes higher standards of transparency and accountability in public procurement. Similarly, we are cautious on Gamuda’s property development business due to an expected prolonged downturn in the local property market.

• Also, with reduced recurring toll road earnings (that make up about 35-40% of Gamuda’s total earnings) post the disposal of Gamuda’s stable of toll road concessions, the defensiveness of Gamuda’s earnings will be eroded, resulting in a higher risk premium. Even if Gamuda is to be able to strike a good deal with the government and raise substantial proceeds from the disposal, it will take time for it to identify new businesses to fill up the vacuum.

Source: AmInvest Research - 28 Mar 2019