- We initiate coverage on Eastern and Oriental Bhd (E&O) with a fair value of RM3.00/share – based on a 35% discount to our NAV of RM4.61/share after incorporating the significant accretion to its assets value from Seri Tanjung Pinang 2 (STP2). Stripping out STP2, our NAV stands at RM1.36/share.

- STP2 (760 acres) with its high sea-fronting development potential and lucrative profit margin is the primary valuation driver. Our investment thesis is centred on our conviction that STP2 would be granted regulatory approvals from the Penang state government by 1HCY14 to commence reclamation works.

- STP2 is critical to the Penang state government’s efforts to alleviate traffic congestion on the island via the construction of an undersea tunnel to the mainland. E&O would need to surrender 60 acres in STP2 and reclaim a further 131 acres along the tourist belt of Jalan Gurney for the state government. In addition, the state government also has a 21% stake in STP2.

- Based on our estimates, the break-even land cost for STP2 is RM85psf (see Table 6), even after factoring the total of 191 acres to be given to the state government. In our NAV model, we have assumed a fair market value of RM250psf to arrive at our NAV of RM4.61/share, which is significantly above the current consensus NAV of between RM3.00/share-RM4.00/share.

- Given its strong pre-sales pipeline comprising several prolific projects, namely Avira Wellness in Iskandar and Princess House redevelopment in London, we forecast earnings to expand by a CAGR of 18% over the next three years, from RM141mil in FY14F to RM200mil FY16F. We have not factored in any earnings contributions from STP2. Any land sale at STP2 would accelerate its profit growth trajectory.

- E&O has only just started to access its major shareholder Sime Darby’s vast landbank. It recently entered into a Memorandum of Agreement to acquire 135 acres of prime residential land in Sime Darby’s new flagship project City of Elmina, located along the Guthrie Corridor Expressway. The said land is earmarked for a lifestyle and wellness-themed project.

- Balance sheet is healthy with a net gearing of 33% as at 1QFY14 and unbilled sales of RM550mil (just under 1x FY13’s revenue) as at end-August. As STP2 would be reclaimed over two phases, it appears unlikely that E&O would need to do a rights issue, we believe. E&O is committed to maintaining its dividend policy of 30%. 

Source: AmeSecurities