Muhibbah Engineering (Muhibbah)’s share price has so far risen by 41% since our buy call in our 3Q13 Strategy piece dated 2nd July 2013. We have reviewed our earnings forecasts and valuation  and made minor adjustments in our earnings estimates by 4% - 7% in FY13 and FY14. While maintaining our OUTPERFORM call, we raised our Target Price (TP) from RM1.90 to RM3.00 based on SOTP valuation. All in, Muhibbah remains our Top Pick in the small-mid cap construction space premised on the following investment merits: (i) its primary activities are in current booming O&G sector (i.e. infrastructure construction, 62%-owned Favelle Favco (Favelle)’s cranes, marine shipbuilding and repair), (ii) higher conviction on the Group to secure O&G jobs after licensed by Petronas as O&G offshore fabricator, and (iii) long-term earnings visibility backed by growing recurring income from its concessions. 

O&G’s share rising. We are now appreciating Muhibbah more as an O&G play rather than that of construction. Although Muhibbah is still considered a small newcomer in the O&G industry, it is an emerging O&G stock with great potential. It has organically grown its O&G orderbook share of total order to 50% currently from only 35% in 2007. More importantly, Muhibbah’s activities mostly lie within the booming O&G sector. The Group’s core businesses namely infrastructure construction, cranes, and marine building and repair are all O&G-related and complement each other. Additionally, the recently obtained Petronas license has further reinforced our view that Muhibbah will continue to ride on the robust O&G services sector which provides good earnings visibility. 

Construction: Additional RM600m new contract from O&G next year? We understand Muhibbah has already pre-qualified to tender for 3 packages of Petronas’ RAPID projects. Given its excellent track record with Petronas (i.e. Melaka regasification project), we believe Muhibbah’s chances to secure at least one package from Petronas is bright. Conservatively, assuming Muhibbah is able to clinch an additional RM600m on top of our assumed RM700m (i.e. RM1.3b total) new jobs from Petronas’ RAPID in FY14, our SOTP-derived valuation will be revised 9% higher to RM3.27.  

Leveraging on Favelle’s name.  Besides consistently reaping profit from Favelle’s healthy orderbook of RM865m, Muhibbah could also leverage on Favelle’s internationally-recognised name and branding. Favelle is globally recognised where its customers are geographically spread around the world. In fact, Muhibbah’s JV partner for the Wiggin Island Coal Export Terminal (WICET) project, Monadelphous, is also one of Favelle’s clientele. In addition, Favelle’s crane operations complement its infrastructure construction and marine shipbuilding and repair divisions. 

Concessions: growing recurring income. We also have revised higher concessions division’s contributions by 5% - 6% in FY13 and FY14 respectively as we expect its both airport and road maintenance to continue to grow taking into account (i) extra income from road concessions starting FY12, and (ii) higher airport passenger growth. Going forward, it is expected that Muhibbah is likely to secure other airport concessions such as the Mandalay International Airport in Myanmar. We understand Muhibbah and its JV partner, Vinci is one of the shortlisted concessionaires for the airport. Should MuhibbahVinci JV win the concession, it will definitely boost its recurring income base.

Maintain OUTPERFORM with higher TP of RM3.00.  While maintaining OUTPERFORM call on Muhibbah, we revised higher our  TP to RM3.00 from RM1.90 based on SOTP valuation. Our higher TP revision is after taking into account: (i) higher valuation of its concessions segment (i.e. airport  and road maintenance), where we have earlier underestimated the division’s earnings and valuation, (ii) switching valuation methodology of 62%-owned Favelle Favco (Favelle) to relative-PER valuation from mark to market cap previously, (iii) higher forward-PER of 10x from 9x for its construction division due to O&G exposure in its orderbook profile, and (iv) balance sheet housekeeping. All in, Muhibbah remains as our Top Pick in the small-mid cap construction space premised on the (i) its business activities are mainly in the booming O&G sector (i.e. infrastructure O&G construction, cranes through well-known Favelle, marine shipbuilding and repair), (ii) higher conviction on the Group to secure more O&G jobs after licensed by Petronas as O&G offshore fabricator, and (iii) long-term stable recurring income base from its concessions.

Source: Kenanga