Results

• Gadang reported a net profit of RM10.9m for its 2QFY20 result as compared to a net profit of RM15.0m in its 1QFY20 and RM16.9m for its 2QFY19.

• Lower QoQ earnings. The Group delivered a higher revenue of RM197.7m (+34%) but net profit was down to RM10.7m (-29%) no thanks to higher administration and operating expenses (+13% & +30% respectively). We witnessed EBIT down to RM15.8m (-29%) from RM22.1m. In addition, EBIT margin and net profit margin also dropped from 15.0%/10.2% to 8.0%/5.4% respectively.

• Weaker YoY performance. Revenue increased 17% but the increase in cost of sales to RM169.2m (+21%) offset the bottom line to RM10.7m (-37%). This was also caused by the elevation of operating and admin costs (+24% & +13% respectively).

• 1HFY20 Within expectations. The Group recorded RM345.3m revenue which increased 16% yoy. However, EBIT slumped to RM37.9m, -17% mainly because of higher cost incurred. As a result, 1H net profit fell to RM25.7m, which tumbled 23%. The Group’s 6MFY20 was within our/consensus expectation, matching 47.7%/44.8% of full year net earnings forecast. The moderate performance was mainly attributable to higher cost from construction hiccups.

Comment

• Outlook for Construction division remains challenging. Gadang’s outstanding order book as of 1QFY20 stood at RM1.0b which was below its full load of RM2b capacity no thanks to sluggish local construction sector. Having said that, latest order book will keep Gadang busy for the next 2 years. Gadang has restrategised its business plans by aggressively bidding for government projects instead of private building jobs as the former render lower payment risk in view of prevailing property glut. We understand that the Group’s tender book currently stands at RM0.8-1b including projects such as ECRL in which the Group has been shortlisted under prequalification stage, LSSPV3, Hospital Pasir Gudang, TRX double-storey plaza, Maritime Complex in Sarawak, an earthwork & infrastructure job in Kedah and Sarawak portion of Pan Borneo Highway. Outcomes of the tenders are expected in 1Q/2QCY20.

• Construction margin under pressure. We foresee that the Group’s Construction division will have tough time ahead for its profit margin as operating landscape is getting more competitive with many players chasing after limited projects. Also, slash in project values for few mega projects domestically would weigh on contractors’ margins moving forward. In a nutshell, we shall see Gadang to record mid. single-digit operating margins for its new projects moving forward. Gadang aims to replenish RM300m order book for FY20F which is higher than FY19 secured order book of RM140m.

• Venturing into the overseas market. Gadang has ventured into Singapore market by acquiring a licensed bored piling company in order to penetrate into the market swiftly whilst awaiting the unforeseeable revival of local market. The Group currently owns 3 units of bored pile machine and bids for SGD10m-30m jobs. We are positive with its foreign venture as it allows for portfolio diversification and enhance its overall earnings visibility. Setting up a foreign business arm is not a new case for Gadang but should not be taken lightly in view of this regulated and developed market. We believe Gadang is able to expand its foreign footprint aggressively as we have seen success stories of local peers in other countries.

• Continuous property launches amid prevailing soft market. Gadang plans to launch Laman View (Phase 3), The Vyne (Phase 3), and Semenyih residence (Phase 1A), all in Klang Valley during FY20F despite current lacklustre property market. The Laman View (Phase 3) with RM153m GDV consists of 146 double storey house in Cyberjaya which we believe to capture the favour of market following commendable sales of previous phases which were launched from 2015 till 2017. Meanwhile, The Vyne (Phase 3) with RM112m GDV consists of 152 condominium, pegged at RM800psf selling price believes to be targeting “mid to high-end” clientele. Lastly, Semenyih residence (Phase 1A) with RM66m GDV will be made up by 152 units of 3-storey terraces. We expect positive responses on both Laman view and Semenyih residence due to scarcity of landed housing project within Klang Valley. However, we are skeptical on The Vyne (Phase 3) due to its steep pricing and oversupply of high-rise residences in Klang Valley. Furthermore, the take-up rate for Phase 2 still at 72% since it was launched in 2014.

• Anticipating higher property sales for FY20F. Gadang envisages better property sales for FY20F with target new sales of RM273m, which is higher than its FY19 actual sales of RM163m banking on more property launches this year. Meanwhile, the Group’s unbilled sales stand at RM123.5m as of 1QCY20, which provide earnings visibility for the next 1-2 years.

• Revival of Capital City project in JB. To recap, due to poor market condition in JB property market, the project developer and Gadang (being the landowner) entered into a variation of the JV agreement last year to revive this mixed property project which was launch few years ago. With the financing issue coming into fruition after settlement of land pledging and ownership transfer, Gadang is now entitled for RM250m development profit of which RM150m has been received by the Group. Hence, the Group’s remaining entitlements worth RM100m are in the form of 400 units of retail lots and RM20m cash. We shall expect the Group to receive those proceeds in FY21F.

• Self-sustaining Utility division. Gadang secured a contract of building a 9-Megawatt mini hydro power plant in Kabupaten Tanah Datar, Sumatera Barat with 15 years power concession. The Group has granted the plant construction contract to local player in order to adhere “localization” stance of the host government. We shall expect the Group to complete and commission the plant by 1QCY20. In addition, the Group is planning to build a large scale solar PV Plant of 5.9 Megawatt in Kota Mardu, Sabah. Gadang now is in the midst of looking for strategic location for the plant which takes into account land cost, grid connectivity, land suitability, and others to maximize the long term efficiency.

Earnings Outlook/Revision

• We marginally tweak up our FY20F net earnings forecasts by 0.9% to RM54.3m after accounting for slightly better construction and property divisions in FY20F and potential variation order from RAPID project which is likely to be booked in 2HFY20F and better earnings for FY21F on capital city proceeds. We have also increased earnings forecast of FY21F from RM58.1m to RM74.1m on the back of potential extra contracts will be secured and higher property sales in 2H2020.

• Positive outlook banking on: (a) Revamp of government policy with leadership handover, (b) Lower cost of financing on OPR cut, and (c) Re-emerging interest on construction sector with faster projects execution and awards.

Valuation & Recommendation

• Upgrade to HOLD from SELL with a higher target price of RM0.67 from RM0.63 previously following our slight earnings lift and higher PE multiple applied. Our valuation is now pegged at 9.5x (from 9x) FY20F PE with a revised EPS of 7.5 sen (7.2 sen previously), which is close to its +1.5 standard deviation above its 3-year historical mean P/E as we believe worst is over for the construction sector and better projects newsflow ahead

Source: JF Apex Securities Research - 23 Jan 2020