SunCon announced that its 60% owned JV was awarded a Rs.864.5 Crore (c.RM500m) Indian highway project. The project will be undertaken through a hybrid annuity model which significantly lowers risk for the contractor. Management guided that PBT margins for the project are expected to come in above 10%. Post- funding, we reckon SunCon will sustain its net cash position. Cut FY20 earnings by -0.6% and increase FY21-22 earnings by 3.5% and 1.5% due to project timing. Maintain BUY with unchanged TP of RM1.73, based on an unchanged 15x PE multiple tagged to FY20 earnings.

NEWSBREAK

Overseas venture. SunCon announced that its JV, SunCon-RNS Infrastructure Limited (60:40) accepted the Letter of Award (LoA) issued by the National Highway Authority of India (NHAI) for tolled highway project with total contract sum amounting to Rs.864.5 Crore (c.RM500m). Additionally, the JV has been awarded a 15 year operating and maintenance contract worth Rs.7.08 Crore p.a. (c.RM4m p.a.). The scope of works entails the four laning of Thorapalli Agraharam – Jittandahalli Section of NH-844 from Km 25.000 to Km 63.500 (existing chainage) corresponding to Km 23.350 to Km 60.100 (Design Chainage) under Bharatmala Pariyojana Phase-I (National Corridor). Works are expected to commence in Oct-20 with a construction period of 2 years.

HLIB’S VIEW

Low risk model. The project will be undertaken through a hybrid annuity model (HAM) in which SunCon does not undertake traffic volume risks with regards to the repayment (no tolling rights). Based on the terms of the agreement, NHAI will pay 40% of the project cost within the first two years of the construction period in five equal instalments whereas the remaining 60% is paid over 15 years as fixed annuity amount plus interest (benchmarked at Reserve Bank of India rate + 3%). Essentially, compared to the BOT model, HAM transfers traffic volume and financing (partially) risks to the government resulting in significantly lower risk for the contractor. Management guided that PBT margins for the project are expected to come in above 10%. We anticipate relatively stable margins for the project as it carries a built-in price escalation clause.

Funding. For the project, the JV (60% SunCon) intends to inject c.RM50m cash with the remaining to be financed through debt facilities. We gather that the terms of the debt mirror the fixed annuity amount plus interest paid by NHAI. Effectively, this allows SunCon to hedge against interest rate risks arising from the debt. Post funding requirements, we estimate SunCon will preserve its net cash position (approximately 12% of market cap post-funding).

Familiar partner. Its JV partner, RNS (40%) is an Indian local company that provides wide range of infrastructure construction services such as construction of dams, highways, bridges, tunnels, power houses, and residential buildings. RNS was also SunCon’s JV partner during its first foray into India in 2001.

Forecast. While the job award falls within our replenishment assumptions, we cut FY20 earnings by -0.6% and increase FY21-22 earnings by 3.5% and 1.5% after factoring in recognition timing for the project.

Maintain BUY, TP: RM1.73. Maintain BUY with unchanged TP of RM1.73, based on an unchanged 15x PE multiple tagged to FY20 earnings. We like SunCon due to (i) strong balance sheet (net cash: 21% of market cap) (ii) solid execution track record and (iii) strong support from parent-co.

Source: Hong Leong Investment Bank Research - 27 Mar 2020