• MoF reviewed the MRT2 project and made major changes in which i) the elevated/above ground portion would be done by the MMC-Gamuda under turnkey model; and ii) outstanding works for the tunnelling contract would be retendered.

• This is negative for Gamuda as the orderbook loss in tunneling works is worth RM5.26bn (net to Gamuda) while we believe the elevated/above ground portion, worth RM6.27bn, would be done at lower margins and higher execution risk.

• These led to us slashing our FY19F and FY20F earnings by 37.0% and 29.3% respectively to reflect the loss in tunnelling orderbook and unfavourable margin for above ground portion.

• Downgrade to SELL (from BUY) with an SOP-derived TP of RM2.75 (from RM4.30). We see no real catalyst for the sector in the near term as government trims infrastructure spending.

A weakening surprise

MoF announced major changes to the MRT2 projects as part of its plan to lower government’s debt burden. Firstly, the elevated/above ground portion would be converted to turnkey model from PDP, lowering costs to RM17.42bn or by 23% from RM22.64bn. Secondly, termination of the tunnelling works contract with MMC-Gamuda. The outstanding works would be and retendered to achieve lower construction costs.

Loss on high margin tunneling works

These developments are negative for Gamuda (Table 1) due to as follow: i) while the conversion of the aboveground/elevated portion to turnkey model lifts Gamuda’s MRT2 orderbook to RM6.27bn from RM5.26bn, it also incurs higher risk and would most likely, in this instance, carried out at a tighter margin, ii) cancellation of the tunnelling works eliminate RM5.26bn worth of orderbook and a far more lucrative portion due to its technical challenges.

Cutting earnings forecast

Based on our estimates, these unexpected developments lowers our FY19F/FY20F earnings forecasts by 37.0%/29.3% respectively. Our forecasts also imply a significantly lower contribution from the construction division moving forward which erodes Gamuda’s core earnings drastically.

Downgrade to SELL with revised TP of RM2.75

We downgrade our call to SELL with revised SOP-derived TP of RM2.75 (from RM4.30). The surprise move by government reaffirms its prudent spending on infrastructure which underlines our take on the sector’s uninspiring outlook over the near to medium term.

Source: BIMB Securities Research - 8 Oct 2018