Margin improvements sustainable moving forward on transitioning to performance based contracts. Pan Borneo Sabah consultancy works still on going despite redefined objectives. Healthcare segment future performance to be buoyed by forays into commercial hospitals and overseas jobs. The stock remains a fantastic exposure to a stable earnings stream at undemanding valuation. Reiterate BUY and an SOP based TP of RM2.97 (+33.2% upside).

We Attended UEM Edgenta’s 1H18 Results Briefing and the Key Points Are:

Performance based. With the partial implementation of performance based contracts “PBC” for PROPEL since Aug, we can expect a stronger showing in 2H18 for the infra division in addition to a historically stronger 2H. Beginning Jan 2019 the group will fully transition to PBC for PROPEL. To note the PBT margins improvements by 1.1ppts YoY in 1H18 from their infra division has yet to fully reflect the cost savings and margin enhancing elements of the PBC.

Sharing is caring. Management shared that the margin enhancements will be “shared” with PLUS. To offset the additional capex, we can expect PROPEL to “inquire” for more work-flow from the existing 60% of jobs currently allocated by PLUS. This will make up for any shortfall in cost savings shared with PLUS. Thus protecting margins whilst shoring up revenues, theoretically.

Capex. Management guided capex allocation of c.RM100m in FY18-19. For PBC’s, the risk of performance of the road passes to the concessionaire, thus requiring investments/R&D in more durable products: pre-fab, glass grit materials for pavement etc. Their R&D drive is expected to save c.RM20m p.a. moving forward vis-a-vis existing materials utilized based on input based contract.

Sabah. Consultancy works are still ongoing in for Pan Borneo Sabah (PBS) in FY18. The scope might’ve been redefined i.e. aiding PDP to minimize work flow and costs but consultancy work is very much being undertaken. Furthermore we are of the opinion that PBS will likely proceed, perhaps at the expense of the PDP model. Assuming a competitive open tender basis moving forward, Opus M’sia will remain at the forefront for consideration to carry on the consultancy work given its prior involvements.

Pacifying the naysayers. To give some colour to contract review situation, the PMO contract amount outstanding is c.RM500m (15 years to go) and Sabah PDP c.260m (10 years to go). Assuming that they lose both these contracts with no compensation, this amounts to only c.5.6% of their total outstanding estimated work in hand (RM13.5bn) as at end 1H18.

Healthcare. This segment will be largely buoyed by overseas expansion moving forward. We understand that Singapore’s MOH is restructuring their hospital clusters from 6 to 3 and are re-tendering cluster projects on bulk basis. Currently the procurement model is tendered on an individual basis. Edgenta’s SOM in SG of c.30- 40% is limited to housekeeping and portering. The group is looking to bid for higher value/margin jobs such as medical equipment servicing moving forward. For Malaysia, the strategy is to penetrate commercial hospitals (IHH), which in our opinion is fathomable due to the Khazanah connection.

Maintain BUY, TP: RM2.97. We reiterate that valuations are undemanding as the stock is trading at FY19-20 PER of 12.4-12.6x with a dividend yield of 5.7%-5.6%. Edgenta offers exposure to a stable earnings stream at an undemanding valuation. Reiterate BUY, our SOP based TP of RM2.97 provides as upside of 33.32%.

Source: Hong Leong Investment Bank Research - 5 Sept 2018