The Malaysian government has rescinded its earlier decision to terminate MMC Gamuda Joint Venture’s (JV) contract for the Klang Valley MRT Line 2 (MRT2) underground works. The contract value will be reduced by RM3.6bn to RM11.9bn. We raise our core EPS by 7-16% in FY19-21E to reinstate earnings contribution from the MRT2 underground contract under new terms. We upgrade our call on Gamuda to HOLD from Sell with a lifted TP of RM2.70, based on 30% discount to RNAV.

Contractor Retained

The Malaysian government has agreed to retain MMC Gamuda JV as the turnkey contractor for the MRT2 underground works after the latter agreed to increase the cost reduction from RM2.13bn to RM3.6bn. Together with the earlier cost cut of RM5.22bn for the above-ground contract, the MRT2 construction cost will be reduced by 22% from RM39.35bn to RM30.53bn.

Substantial Order Book

We understand that MMC Gamuda JV’s MRT2 underground contract value will be reduced from RM15.47bn to RM11.87bn. Physical completion rate is at 40% currently for the underground works. We estimate that Gamuda’s 50% share of remaining MRT2 underground works is RM3.7bn following the contract value revision. Its large remaining order book of about RM8.8bn will sustain its construction activities up to mid-2022.

Profit Margin Sacrifice

We gather that Gamuda’s PBT margin of 15% for the MRT2 underground contract will be reduced to about 5-6%. We believe the sacrifice in profit margin is preferable to a termination of the contract. By remaining as the turnkey contractor the MRT2 project and settling the earlier disagreement with the new government amicably, Gamuda will retain its competitive advantage in future MRT projects in Malaysia such as the MRT3. Assuming PBT margin of 5% for the remaining underground works, we lift our core EPS forecasts by 7-16% in FY19-21E (partially reversing our downgrade previously, which assumed the contract was terminated).

Upgrade to HOLD

We lift our RNAV/share to RM3.86 from RM3.65 previously to reflect higher construction division valuation (raise sustainable earnings to RM100m from RM50m previously and apply the same PER to 12x). Based on the same 30% discount to RNAV, we lift our TP to RM2.70 from RM2.55. We upgrade our call on Gamuda to HOLD from Sell following the sharp correction in the share price to close to our new TP. Key upside/downside risks are higher/lower new contract procurement.

Source: Affin Hwang Research - 29 Oct 2018