Investment Highlights

• We raise our FY19-21F net profit forecasts by 24%, 16% and 18% respectively and FV by 9% to RM2.91 (from RM2.64) based on “sum of parts” (SOP), valuing its construction business at 10x forward earnings, in line with our benchmark forward target P/E of 10x for large-cap construction stocks (Exhibit 2). However, we maintain our UNDERWEIGHT call.

• Gamuda's 9MFY19 net profit beat expectations, coming in at 94% and 85% of our full-year forecast and the full-year consensus estimates respectively. The key variance against our forecast came from lower-than-expected margin erosion from the downsized MRT2 project.

• Nonetheless, its 9MFY19 net profit still declined 18% yoy due to weaker performance from construction (downsized MRT2 contract) and concessions (absence of contribution from Splash post its disposal), partially offset by better showing from property (strong sales and firm margins in Vietnam).

• Gamuda recorded RM2bil property sales in 9MFY19, with overseas projects (largely in Vietnam) contributing more than half of the total. It lowered its FY19F property sales target to RM3.5-3.8bil (from RM4bil) largely to reflect the weaker-than-expected sales from its new local township projects in the Klang Valley, i.e. Gamuda Gardens (near Rawang), Gamuda Cove (near Nilai) and Twentyfive.7 (near Kota Kamuning), largely due to “initial hiccups” (such as the delays in the completion of excess roads). At present, Gamuda’s unbilled sales stand at RM2.2bil, which is unchanged from three months ago.

• Key highlights from the briefing yesterday evening are:

1. Gamuda guided for a special dividend funded by RM3.4bil proceeds from the disposal of its water and toll road concessions, but the quantum is yet to be decided;

2. Gamuda banks a lot on the Penang Transport Master Plan (PTMP) project to rebuild its recurring income stream, post the disposal of its water and toll road concessions. The PTMP project could fetch stable project delivery partner (PDP) fees for many years to come. The initial components of the project, i.e the RM8bil LRT line, RM8bil Pan Island Link (Phase 1) and the reclamation of the 800-acre “Island A” under the Penang South Reclamation project alone, would take at least 7-8 years (concurrently) to complete;

3. While Gamuda appeared confident that the PTMP project will get off the ground in 2H 2020, it did not elaborate much on the project’s funding (which we believe is the most critical aspect of the project), other than saying that it could come from Asian Development Bank (ADB) (“as they like the project very much, particularly, the LRT component”) or the Ministry of Finance. When asked about the funding structure of the potential ADB loan, Gamuda’s response was a bit of a let-down: “it’s still early days”;

4. Gamuda said that it is not keen on the East Coast Rail Link (ECRL) project as it expects the Chinese turnkey contractor to only dish out low-value portions of the project to local contractors. Gamuda is not prepared to commit its resources to a low-margin job over a long period of time (given the hefty opportunity cost); and

5. Gamuda painted a rosy picture for the local construction sector, predicting that the government may restart the MRT3 project as soon as in 2021 as it finances stabilise. However, at the same time, Gamuda said that it has identified and is making forays into four overseas markets, i.e. Australia, Singapore, Taiwan and Vietnam. It has just set up an office in Sydney with a staff strength of 16 people. It said that it is bidding for projects mostly in Victoria and New South Wales worth a total of A$15bil and is confident about securing at least A$2bil.

• We sense Gamuda’s high “concentration risk” in the PTMP project. In the event the project fails to get off the ground timely (2H 2020 as guided) or Gamuda being given a reduced role in the project (as the PDP model is no longer favoured by the federal government, as manifested in the cancellation of the PDP model in the construction of LRT3, MRT2 and Pan Borneo Highway Sabah, while a decision is pending for Pan Borneo Highway Sarawak). We are also mindful of the potential initial “school fees” Gamuda may have to pay in order to gain a foothold in the new overseas construction markets.

• We maintain our view that valuations of construction stocks, Gamuda included, have run ahead of their fundamentals in the heat of the euphoria sparked by the recent revival of the ECRL and Bandar Malaysia projects (more so, Gamuda may not even participate in the ECRL project after all). We believe the fact remains that given the still elevated national debt, the government has no choice but to remain steadfastly committed to fiscal prudence which means the revival of the ECRL project could be a “zero-sum game” as it impedes the government’s ability to implement other public infrastructure projects.

Source: AmInvest Research - 28 Jun 2019