Post-meeting with management, we remain cautious regarding the company’s prospects. Headwinds persist for its construction segment with questionable near term replenishment prospects compounded by a thin orderbook. Metering utilisation rate stands at 60% and should normalise by 2HCY20. We cut our FY21 earnings by 6.5% and increase FY22 earnings by 27% after factoring in progress billings delays. Maintain SELL with TP of RM0.52 after earnings adjustment. Our TP is derived from pegging FY22 EPS to 6.6x PE multiple.

We Held a Virtual Meeting With GKent Recently With the Following Key Takeaways:

Construction. GKent’s outstanding orderbook (ex-LRT3) stands at c.RM300m which translates into cover ratio of 1.22x of FY20 construction revenue. Construction works for its hospital projects have yet to recommence pending receipt of Covid-19 test results. Management revealed that pace of construction works may not normalise to pre-MCO levels due to SOP guidelines (social distancing measures) in-place. Prior to the shift in government, completion timeline for its hospital projects were originally slated to be extended to 1HCY21 from CY20. Given the pandemic, further extensions to the timeline look likely.

LRT3. LRT3 orderbook stands at c.RM4.6b with a completion rate of 24%. We reckon it may miss its targeted 40% completion rate by end CY20 due to the MCO. Nevertheless, finalisation of the novation agreements have been ongoing and are expected to be concluded in the next couple of months. We gather payment for the project has been ongoing despite the MCO.

Metering. As it stands, GKent’s utilisation rate is at 60%, having resumed operations since mid-April (pre-MCO utilisation rate stood at 70-75%). GKent’s long-term license agreement with Honeywell has facilitated the transfer of technology and associated machinery tools to the former for manufacturing high-precision water meters (V100 and V110 C-Class volumetric water meters). Company aims to rollout new products encompassing multi-jet meters (2HCY20) as well as D-Class volumetric meters (4QCY20) both geared for overseas markets. GKent intends to target developing markets (Myanmar, rural Vietnam and Philippines) with its cheaper multi-jet offering while its D-Class volumetric meters are meant for more affluent countries (Singapore, Hong Kong, Australia, Europe).

Outlook. Given the dearth of railway construction contracts in the pipeline, we anticipate limited near term orderbook replenishment potential. While we foresee increasing pump priming initiatives by the government moving forward, job awards are unlikely in the short term. To combat this, GKent is targeting to grow profit contribution from its metering division to 50% in the short to medium term.

Forecast. We cut our FY21 earnings by 6.5% after recalibrating progress billings to FY22. Hence, our FY22 earnings increase by 27% upon factoring in higher progress billings and margin normalisation. We introduce FY23 earnings forecast of RM30m.

Maintain SELL, TP: RM0.52. Despite our view of a likely resuscitation of pump priming initiatives by the government, we reckon earnings downside risks remain aplenty should job awards not materialise to arrest a quickly thinning orderbook. Suspension of its dividend payments should also amplify risks to the downside. Maintain SELL with a slightly higher TP of RM0.52 (from RM0.50) after switching our valuation methodology from SOP to PE method due to its shrinking earnings base in both segments. Our TP is derived from pegging FY22EPS to 6.6x PE multiple (-1SD below 3-year mean).

Source: Hong Leong Investment Bank Research - 23 Jun 2020