Investment Highlights

• We trim FY19-20F earnings forecasts by 1% each, fine-tune down our FV by 1% to RM3.34 (from RM3.36), and maintain our HOLD call. Our new FV is based on 13x revised CY19F FD EPS of 25.7 sen, in line with our benchmark forward target P/E of 11-13x for large-cap construction stocks.

• The Selangor state government, via Pengurusan Air Selangor Sdn Bhd, has made an offer (closing on 27 Aug 2018) to Gamuda Water, Gamuda’s 80%-owned water treatment plant operation & maintenance (O&M) operator, for:
  1. the termination of the existing O&M agreement between Gamuda Water and Splash for Splash’s Sungai Selangor Water Treatment Plant Phase 3 (SSP3);
  2. the settlement of the amount owed (receivables) by Splash to Gamuda Water via an upfront payment of 10% plus nine equal annual instalments (bearing a 5.25% p.a. interest until settled); and
  3. the execution of a new SSP3 O&M agreement between Gamuda Water and Splash with revised bulk-water supply rates (BSR) of 44 sen/m3 (up until 2018), 46 sen/m3 (2019-2022), 47 sen/m3 (2023) and 53 sen (2024- 2029), which represent about a 2 sen/m3 reduction vs. the rates under the existing SSP3 O&M agreement.
• We believe Gamuda Water will accept the offer. Based on our estimates, the effective “haircut” from the revised BSR to Gamuda Water’s PBT is only at about RM7.4mil (2 sen x capacity of 1,050 million litres per day x 365 days x 96% utilisation), shaving the estimated Gamuda Water’s annual PBT of RM60mil by only 12%. Gamuda’s effective share of the “haircut” is only RM5.9mil at the PBT level based on its 80% stake in Gamuda Water. We have reflected this in our earnings forecasts. Also, by accepting the offer, Gamuda Water will effectively lock in decent recurring incomes for the next 11 years.
• We believe the latest development in a big positive vs. the earlier concern about the prospect of Gamuda Water having to lose the SSP3 O&M contract all together.
• We remain cautious on the outlook for the local construction sector as the government cuts back on public infrastructure projects on grounds of fiscal prudence. While the rollout of public infrastructure projects will resume over the medium term as infrastructure development remains key to nation-building, we believe the focus will shift to smaller scale/value-for-money basic infrastructure projects such as road upgrading, bridges, schools, drainage, rural water and electricity supply and smallish sewerage schemes, from multi-billion mega projects. The smaller projects are less economical to large-contractors such as Gamuda, given their high fixed overheads.
• Not helping either, are the prolonged downturn in the local property market that weighs down on Gamuda’s property division, and the uncertainty arising from the potential expropriation of Gamuda’s toll roads.

Source: AmInvest Research - 23 Aug 2018