Investment Highlights

• We maintain our UNDERWEIGHT call, forecasts and FV of RM1.20 based on 10x FY20 EPS, in line with our benchmark forward P/E of 10x for large and mid-cap construction stocks.

• Privately-owned developer PNSB Acmar Sdn Bhd (PNSB Acmar) has initiated a civil proceeding against Prasarana Malaysia Bhd (the first defendant, project owner of the LRT3) and Sunway Construction (the second defendant, works package contactor for Packages GS07 and GS08 of the LRT3).

• PNSB Acmar is claiming that structures of the LRT3 project currently under construction such as poles, bars and stations have trespassed/encroached into its property project, resulting in it suffering losses and damages.

• It is seeking special damages of RM711.4mil (plus the accrued interest at 5% per annum), legal cost of RM400,000 and “declarations, injunctions, orders and other reliefs the court deems fit”.

• We understand from sources that the property project in question is the Acmar Hotel project, which has been in slow progress for years, near AEON Bukit Raja in Klang (the horizontal V-shaped superstructure of the hotel project is highly visible along the Federal Highway heading towards Klang).

• We are not in a position to predict the outcome of the court case given that: (1) as financial analysts, we do not possess the necessary legal expertise to do so; and (2) the lack of the detailed facts of the case. However, we believe that the risk on Sunway Construction’s earnings from the court case is low given that:

1. PNSB Acmar will first have to prove an encroachment;
2. If there has been an encroachment, Sunway Construction will only be liable if the encroachment is a result of it failing to carry out construction activities in accordance with the instruction from client Prasarana (otherwise, logically, Prasarana will be the sole party liable for the encroachment); and
3. Even if PNSB Acmar can prove an encroachment and that Sunway Construction is liable for the encroachment, whether special damages of RM711.4mil is justifiable (the basis for the very hefty number is unknown)
    

• We are keeping our assumptions of construction job wins of RM1.8bil in FY19F and RM1.5bil annually in FY20– 21F, and precast product order replenishment of RM200mil annually in FY19–21F. So far in FY19F, it has secured new construction jobs worth RM1.5bil and new precast product orders worth RM60mil. Its outstanding construction and precast product order books stand at RM5.5bil (Exhibit 1) and RM294mil respectively.
   
• We maintain our view that valuations of construction stocks, Sunway Construction included, have run ahead of their fundamentals in the heat of the euphoria sparked by the recent revival of the East Coast Rail Link (ECRL) and Bandar Malaysia projects (more so, Sunway Construction may not even be participating in the ECRL project as the high-value portions of the Chinese-controlled turnkey construction job are unlikely to be made available to local players).

• 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.

• We believe Sunway Construction can weather the sector downturn better given its proven ability to compete under an open bidding system, coupled with the availability of building jobs from its parent and sister companies under the Sunway Group. However, valuations are unattractive at 16–20x forward earnings on muted sector prospects.

Source: AmInvest Research - 18 Nov 2019