Sunway’s 1QFY20 core PATMI of RM66.4m (-70.1% QoQ, -51.9% YoY) was below expectations largely due to lower than expected contributions from the Construction, Property Investment and Healthcare segments. New effective sales of RM522m was achieved (37% of full year target) while effective unbilled sales stood at RM2.6bn (4.8x cover). Sunway is also expected to recognise c.RM160m of profit from the handover of its projects in Singapore and China. We expect FY20 to be a challenging year with the Hospitality and Leisure operations to be likely hit the hardest. We decrease our FY20/21/22 earnings forecasts by -20.5%/-9.4%/-5.9%. Maintain BUY with a lower TP of RM2.00. Separately, Sunway proposed the rights issue of up to 1.1m new ICPS at a n issue price of RM1.00 per ICPS (1:5). Assuming maximum subscription, our TERP amounts to RM1.82.

Below expectations. Sunway’s 1QFY20 core PATMI of RM66.4m (-70.1% QoQ, - 51.9% YoY) forms 10.5% and 9.5% of our and consensus full year forecasts, respectively. The results shortfall was due to lower than expected contributions from the Construction, Property Investment and Healthcare segments. No dividends were declared.

QoQ/YoY. 1QFY20 core PATMI decreased -70.1%/-51.9% to RM66.4m largely due to lower contributions from the Construction and Property Investment segments amidst the MCO restrictions. Note that QoQ recorded a larger fall as 4QFY19 saw the partial recognition of the Tianjin project and improved treasury operations contribution.

Property development. New effective sales of RM522m was achieved in 1QFY20, representing 37% of its full year target. Effective unbilled sales stood at RM2.6bn, representing a strong cover ratio of 4.8x on FY19’s property revenue. Sunway will only be relooking into any potential revision in effective sales (RM1.4bn) and launch targets (RM3.3bn) once the CMCO ends. Note that bulk of the sales achieved came from its recent Parc Canberra (Singapore) launch.

Construction. SunCon reported 1QFY20 core earnings of RM17.6m (-52% QoQ, - 40% YoY) while current orderbook stands at RM5.4bn which implies a healthy cover of 3.1x on FY19 construction revenue.

Healthcare. The segment reported a loss of -RM4.5m PAT as it was impacted by SMCV registering an operating loss of -RM12m. The overall performance was also impacted by the Covid-19 fear as number of admissions and outpatient treatments have dropped with elective surgeries being postponed.

Outlook. We expect FY20 to be a challenging year with the Hospitality and Leisure operations to be likely hit the hardest. Nonetheless, Sunway has activated its BCP which incorporated its digital platform to facilitate the operational disruptions of the MCO while several cost saving measures have been carried out including recruitment freezes. On the property front, the recent digital campaign which was rolled out towards end-April recorded RM200m in bookings within a month. Furthermore, we gather that several local projects which have gotten the necessary approvals have resumed construction works. Sunway is also expected to recognise c.RM160m of profit from the handover of its projects in Singapore and China.

Forecast. We decrease our FY20/21/22 earnings forecasts by -20.5%/-9.4%/-5.9% to reflect lower contributions from the Construction. Property Investment, Healthcare and slightly delayed property launches.

Maintain BUY but with a lower TP of RM2.00 (from RM2.07) based on a 10% holding discount to SOP-derived value of RM2.22 as we impute our forecast changes and roll over our valuation post-bookkeeping adjustments. Sunway remains our top pick given its well-integrated property and construction segments. Its hidden gem, the healthcare business (with 4 new hospitals coming on stream over the next three years) has yet to be appreciated as it is embedded within the parent-co. These coupled with the resilient earnings from mature investment properties alongside its growing building materials business and quarry operations justifies for the re-rating of the stock.

Proposed corporate exercise:

Rights issue. Sunway has proposed the rights issue of up to 1.1m new Irredeemable Convertible Preference Shares (ICPS) at an issue price of RM1.00 per ICPS to all its shareholders on the basis of 1:5 existing ordinary shares held by the entitled shareholders on the entitlement date to be determined and announced later by the Board. We gather that the issue date will likely take place towards end-2020.

Details. Sunway shall at the discretion of the Board pay cumulative preferential dividend at the rate of 5.25% per annum calculated based on the issue price of ICPS of RM1.00 (payable semi-annually in arrears). 50% of outstanding ICPS are to be mandatorily converted immediately preceding the 4th anniversary of the issue date while the remaining balance will be mandatorily converted on the maturity date (i.e. 5th anniversary of Issue Date) at RM1.00 Per Sunway Share.

Proceeds. For illustrative purposes only, the number of ICPS to be issued under the Minimum Scenario is 980m ICPS and under the Maximum Scenario is 1.1bn (assumptions provided in Figure #4). The utilisation of proceeds will be largely allocated to the repayment of borrowings (60%+) while the remaining will be used for hospital expansions (c.20%) and working capital for the Property Development and Investment segments (c.20%). Sunway also intends to procure written unconditional and irrevocable undertakings from its major shareholders to apply and subscribe in full for their respective entitlements which will amount over RM600m/RM700m under both scenarios, respectively.

Proforma implications. Our proforma calculation implies net gearing would improve to 0.33x/0.32x from 0.43x (as of 1QFY20) under both scenario assumptions, respectively. The improved capital structure essentially provides greater flexibility to obtain further financing facilities when needed. There will be no immediate dilution effect towards EPS until the mandatory conversion of the 4th and 5th year. Assuming the Maximum Scenario holds, our TP of RM2.00 would result in a TERP of RM1.82. The issue price and conversion price of RM1.00 both represent a discount of 35.9% (to the 5-day VWAP of RM1.56) and 45% (to our TERP of RM1.82). As such, we believe shareholders should subscribe to this exercise as it provides a decent yield in the near-term while providing for deep value equity participation in the future.

Source: Hong Leong Investment Bank Research - 28 May 2020