News     Gamuda announced that its joint venture entity, MMCEG-Gamuda arbitration against Wayss & Freytag failed and was dismissed, while having to pay Wayss & Freytag the sum of RM96.3m, together with interest thereon at 5.0% per annum from 16 April 2013, and a sum of RM9.0m as cost, totalling to RM105.3m.

Comments     The news caught us by surprise as we did not expect Wayss & Freytag (Malaysia) Sdn Bhd to win the litigation. To recap; in Jan-06, Wayss & Freytag’s contract to construct and complete the North Tunnel Drive of the Stormwater Management and Road Tunnel Project (“SMART”) was terminated by MMCEG-Gamuda due to delays on the progress of its works, which resulted in a material litigation in 2008.

We view this news negatively as it would dampen Gamuda’s earnings in FY13. Although the MMCEG-Gamuda is a 50:50 JV, we understand that the amount to be incurred by Gamuda would be RM77.8m, making up 74% of the total arbitration cost, according to Gamuda’s Bursa announcement. We are unclear the reason for an uneven split of the cost and is seeking further clarity on the matter.

Going forward, similar incidences are less likely to occur in the current MMC-Gamuda KVMRT JV as the current Project Delivery Partner (“PDP”) setup has abetter control over the sub-contractors through a KPI monitoring process i.e. progress milestone. This time around, MMC-Gamuda is also taking direct charge of the tunnelling portion for MRT, which provides them greater control on a high-risk portion of the project, which tends to be prone to delays.

Outlook      Gamuda’s current order book remains healthy at c.RM4.2b, which should last it until 2017. Its outlook remains bright given that Gamuda will be in the running for the tunnelling works for the upcoming MRT line 2 and 3.

Forecast      We are reducing our FY13E earnings by 10% to RM533.2m as we factor in the one-off litigation cost of RM77.8m. There is no impact on FY14E estimates.

Rating      Maintain OUTPERFORM

Valuation       No changes to Target Price of RM4.49 based on an unchanged 14x FY14 PER. Our TP provides an attractive 10% capital upside.

Risks      Delays in construction projects.

Rising building material costs.

Source: Kenanga