Underground Dilemma

The government has decided to terminate MMC Gamuda Joint Venture’s (JV) MRT2 underground contract. This comes as a surprise as we only expected the contract value to be reduced. The above-ground contract value has been reduced by 23% and MMC Gamuda JV has switched to become the turnkey contractor from its previous role as the Project Delivery Partner (PDP). We cut core EPS by 14-18% in FY19-21E to reflect the impact of the MRT2 underground contract cancellation. We downgrade our call to SELL from Hold with a reduced TP of RM2.55.

Surprise Outcome of MRT2 Project Review

The Malaysian government announced that it has accepted MMC Gamuda JV’s offer to undertake the above-ground portion of Klang Valley MRT Line 2 (MRT2) as a turnkey contractor at the cost of RM17.42bn, a 23% reduction from the original cost of RM22.64bn. However, the government decided to terminate the JV’s MRT2 underground contract due to failure to reach an agreement. The underground works will be re-tendered out through an international open tender process.

Uncertainty on MMC Gamuda’s Role

It is uncertain if MMC Gamuda JV will be allowed to participate in the retender of the MRT2 underground works. We believe JV has a competitive cost advantage if it is allowed to participate in the re-tender process. Following the cancellation of the underground contract, we cut core EPS by 14-18% in FY19-21E to remove the contribution from the contract.

Substantial Order Book Reduction (from RM12bn to RM5bn)

Gamuda’s 50% share of works for the MRT2 underground portion has remaining value of RM5.5bn, out of its total construction order book of RM6bn. We estimate Gamuda’s share of the PDP contract for the remaining above-ground works is worth about RM6bn. Assuming a 23% reduction in the remaining share of works, its order book will be reduced to RM5.2bn as it becomes the turnkey contractor for the above-ground portion while the underground contract is cancelled.

Downgrade to SELL

We cut our RNAV/share to RM3.65 from RM4.32 previously to reflect lower construction division valuation (reduced PER to 12x from 14x previously and sustainable earnings to RM50m from RM180m previously). Applying a higher 30% discount to RNAV (20% previously), we reduce our TP to RM2.55 from RM3.46. We downgrade our call on Gamuda to SELL from Hold. Key upside risk is higher new contract procurement.

Source: Affin Hwang Research - 8 Oct 2018