Investment Highlights

• We raise our FY22–23F net profit forecasts by 6% and 18%, but cut our fair value by 15% to RM3.25 (from RM3.81) based on “sum of parts” (SOP) (Exhibit 1). We now value its construction business at 11x forward earnings (from 12x previously), at a slight discount to our benchmark forward target PE of 12x for large-cap construction stocks, to reflect the increased risk of its order book. There is no adjustment for ESG based on our 3-star rating (Exhibit 5). Maintain HOLD.

• Gamuda, via 60%-owned SRC Consortium Sdn Bhd (SRC), will now undertake the development of Island A of the Penang South Islands (PSI) project “through the deployment of private sector capital without any recourse to Penang state government” or a private funding initiative (PFI) model, vs. a project delivery partner (PDP) model previously. Recall, a component of the greater Penang Transport Master Plan (PMTP), PSI entails the reclamation of man-made islands A, B and C with a total area of 4,200 acres at the southern tip of Penang Island.

• In short, SRC will now take the ownership of Island A, in addition to being the contractor of the project.

• The ownership will be held via a 70:30 “project developer” between SRC and a unit of Penang state government. SRC will solely raise the capital requirements for the project developer, while the Penang state government stands to gain a 30% share of profits from future land sales. Given the huge capital outlay, Gamuda guided for a strong possibility that its two 20% partners in SRC may opt out.

• Meanwhile, the award of construction contracts will be handled by a 70:30 “turnkey contractor” between SRC and another unit of Penang state government.

• Key highlights from the briefing yesterday are:

1. 1For a start, only 1,200 acres of Island A known as “Phase 1, Island A” will be reclaimed at a cost of RM6– 7bil over six years commencing immediately. This is assuming a reclamation/common infrastructure cost of RM114 to RM134 per sq ft;
2. Gamuda will solely shoulder the funding for the project and it expects the funding deficit for it to peak at RM4bil in FY25F. Gamuda said that this is manageable based on its projected free cash flow of RM6bil over the next five years, coupled with RM2bil borrowings to be raised. It guided for its net gearing to rise from <0.3x currently to <0.7x at the peak. It also guided for no cash call, neither a reduction in dividends (other than due to the impact from the pandemic);
3. Gamuda hopes to sell Phase 1, Island A for RM8–9bil, assuming a saleable area of 700 acres (with the remaining 500 acres being earmarked for public amenities, canals and landscaping) and at average per sq ft selling prices for industrial, commercial and residential of RM230, RM270 and RM340 respectively. As an indication, industrial land in the neighbouring Bayan Lepas is currently transacted at RM140. The premium for Island A is to reflect the inflation over the next 4–5 years (Island A land sales will only start four years from now) coupled with the premium the land in Island A should command given its superior infrastructure and environment, and its ESG and green certification; and
4. Gamuda guided for an effective RM5bil construction order book (predominantly reclamation) from Phase 1, Island A and a PBT margin of 10%. Our earnings upgrade as mentioned above is to reflect RM1bil construction billings annually from Island A from FY22F, as well as RM2bil construction billings annually from FY23F from Gamuda’s potential job wins in Australia.

• We are taken aback by Gamuda’s decision to put its balance sheet behind Island A. On one hand, this enables the PSI project and the greater PTMP project to finally get off the ground and the immediate realisation of RM5bil order book for Gamuda. One the other hand, Gamuda is effectively sailing into uncharted waters by placing a RM6–7bil bet on reclaimed land in Penang Island (which is very significant as compared with Gamuda’s market value of RM9.2bil currently).

• An investor who bought into Gamuda for its highly cash-generative contracting, water and toll road businesses, could wake up owning a company that is poised for significant cash outflows over a prolonged period of time, i.e. at least four years, before the first land sale could be concluded. Gamuda’s risk-return profile is materially altered. We are unsure if balance sheet-driven job wins are the way forward in the local construction industry but we believe they are certainly a tell-tale sign of a tough market ahead for players.

• This is consistent with our view that government will have very limited room for fiscal manoeuvre in 2021 given the elevated national debt, even before the pandemic. The government’s fiscal position has been weighed down further by the economic impact of the pandemic (including reduced tax and petroleum revenues), as well as the massive relief spending to cushion the economic impact of the pandemic. All these have culminated in Fitch Ratings’ Dec 2020 downgrade of Malaysia’s long-term foreign-currency issuer default rating to ‘BBB+’ from ‘A-‘, on the heels of S&P Global Ratings’ June 2020 downgrade of Malaysia’s outlook to negative from stable).

• Under these circumstances, we believe the government is unlikely to roll out new public infrastructure projects in a major way over the short term. Also, given the suspension of parliament following the declaration of a state of emergency until 1 Aug 2021, the tabling of the 12th Malaysia Plan (which, among others, will earmark mega public infrastructure projects to be implemented in 2021–2025) scheduled for March 2021 could now be put on the back burner.

• We hold the view that the outcome of the PTMP project thus far (i.e. the implementation model for Island A) is not the best investors could have possibly hoped for. However, Gamuda could still spring a surprise or two if it wins sizeable jobs in Australia, or if the Malaysian government decides to pump prime the economy via the implementation of mega public projects despite the high national debt. At 16x forward earnings and with a significantly riskier earnings profile now, we believe Gamuda’s upside is capped.

Source: AmInvest Research - 26 Mar 2021