And The Growth Story Continues…

Following-up on our conference titled “Sarawak Growth Story” earlier this year, we recently went for a study trip to the Borneo region (i.e. Sarawak and Brunei). The trip covered: Kuching, Tanjung Manis, Bintulu, Samalaju, and Brunei. In Sarawak, we visited: (i) CMS, (ii) Hock Seng Lee (HSL), (iii) Tanjung Manis project owner and developer, Sarawak Timber Industry Development Corporation (STIDC), (iv) Bintulu Port (Samalaju Port site visit), and (v) Naim Holdings (Bintulu Paragon project briefing). Meanwhile, in Brunei, we met Bina Puri’s management and visited some of its completed projects. All in, after the packed 4-day trip, we returned home with a POSITIVE feeling about the on-going development in Sarawak, particularly in the SCORE areas that we visited, namely Samalaju and Tanjung Manis. As for Brunei, we are of the view that although the country’s construction sector is growing at a slower pace, this would, over the long-term, benefits Malaysian contractors with presence in the country i.e. Bina Puri, TRC and UEM. In conclusion, with the continued progress in Sarawak’s SCORE, we believe it will continue to benefit the state’s infrastructure companies such as CMS, HSL, Naim Holdings, Bintulu Port, KKB Engineering, and Sarawak Cable in the near-to-long term. Maintain OVERWEIGHT on the Construction sector.

SCORE’s Samalaju is at the active phase of development. We visited one of the SCORE’s growth node area, Samalaju Industrial Park which we witnessed is already at the active phase of construction activities. We also observed that the access roads in Samalaju are getting better when compared to the conditions during our previous visit last year. OM Holdings’ project, a silicone manganese plant (Phase 1), had already taken off and is 40% completed. We also understand that besides the existing 5 investors, there are another 15 investors who had expressed interests to invest in Samalaju Industrial Park. All in, total committed foreign investment since the establishment of the project in 2008 stood at almost RM30b.

Samalaju & Bintulu – A boon for property development? We came away from Bintulu and Samalaju with a POSITIVE view that the physical property surrounding the areas sooner or later will be in high demand due to the expected “deluge of working population” thanks to the SCORE. This is based on our observation and the fact that RECODA’s numbers showing SCORE manpower requirements shortfall by about 144k. Interestingly, CMS, through its 51%-owned associate, Samalaju Properties is the first company to build the township in Samalaju. Naim Holdings also will be building a mixed development project in Bintulu City, Bintulu Paragon, 60 km from Samalaju Industrial Park.

Tanjung Manis: The SCORE’s hidden gem? Sitting on 77k ha of land, Tanjung Manis is set to be the world’s largest Halal Hub. So far, it has secured few investors from Taiwan and Japan. Location wise, it is strategically connected to the far east with naturally deep port facility. Although it is still at the early stages of development, we like the fact that the STIDC is improving its basic infrastructure (i.e. road access, water treatment plants) to accommodate the overall development. This will definitely benefit the Sarawak contractors. HSL is the major contractor of Tanjung Manis, building almost 80% of current infrastructure projects in the district. Other listed contractor is Naim Holdings, which it is building the jetty extension for the Tanjung Manis port.

Brunei: Slowly but steady. We came away from Brunei with a NEUTRAL view on the country’s construction sector. Unlike Malaysia, the country is not in an urgent mode to build mega projects given its less-populated demographic (i.e. 400k) profile. Nonetheless, we understand that the Brunei government is slowly developing the country by improving the infrastructures and increasing number of homes. It is also good to know that the Malaysia contractors namely Bina Puri, UEM and TRC are recognized there as amongst the capable contractors in Brunei. We understand Bina Puri is bidding for some projects in the country i.e. Ministry Of Finance building and bridges.

Beneficiaries. Certainly, CMS is the prime beneficiary from the Sarawak Growth Story. Firstly, it has direct exposure in SCORE’s rapid development of Samalaju through a direct 20% stake in one of the smelter plant operator (i.e. OM Holdings). Secondly it will ride on the robust property demand in Samalaju through its 51%-owned Samalaju Properties. Thirdly, it monopolize the cement supply in Sarawak and lastly it had maintained almost all state roads and half of the federal roads in Sarawak. HSL is another beneficiary, which it is a major marine-related contractor in Sarawak. Meanwhile Naim Holdings, well-known as a major property developer in Sarawak, will also benefit from the robust property demand in Samalaju and Bintulu. We have OUTPERFORM call on Naim with TP of RM4.45. Meanwhile, CMS and HSL are NON-RATED. However, we derived a preliminary fair value for CMS and HSL at RM7.44 and RM2.22 respectively.

Samalaju’s SCORE: Rapidly growing…

SCORE’s Samalaju is at the active phase of development. We visited one of the SCORE’s growth node area, Samalaju Industrial Park and saw that it is already at the active phase of construction activities. We also witnessed that the access roads in Samalaju is getting better as compared to the conditions during our previous visit last year. The OM Holdings’ project, a silicone manganese plant (Phase 1), had already taken off and now is 15% completed. We also understand that besides the existing 5 investors, around another 14 investors had expressed their interests to invest in the Samalaju Industrial Park. All in, total committed foreign investment since the establishment of the project in 2008 stood at almost RM30b.

Replenishment prospects for Sarawak contractors. Hence, it is rather certain that SCORE Samalaju will continue to benefit contractors like HSL, Naim Holdings, and TRC Synergy. In the near-to-medium term, we expect that more basic infrastructure projects to be dished out such as dredging and reclamation, port breakwaters and revetment, access roads and other basic amenities projects.

… boon for property developers?

Bright demographic outlook driven by “working population”... According to Malaysia’s Department of Statistics, in 2010, Bintulu makes up about 9% or 183k out of total Sarawak state’s population of 2.4m. It is the fourth largest town in Sarawak after Kuching, Miri, and Sibu town. Going forward, we would not be surprised if the town could surpass Sibu or even Miri’s population due to SCORE. We like the fact that Samalaju will soon be deluged by “working population” as according to Regional Corridor Development Authority (RECODA), SCORE will create at least 1.3m new jobs. In fact, the RECODA stated that SCORE has manpower shortage of about 144k.

… and Sarawak house prices keep rising but still cheap as compared to Klang Valley and Johor... We also gather that the house prices in Sarawak has picked up for the past 3 years. For example, Naim is launching its Bintulu Paragon at an average of RM500 psf for Small-office-Home-office (SoHo) as compared to that of less than RM300 psf in 3 years ago. Nonetheless, if we were to benchmark this against the prices in Klang Valley and Johor, we believe that there is a lot of potential upside for Sarawak, in particular Bintulu and Samalaju. … to benefit the Sarawak developers. In our view, the main beneficiaries for the booming Samalaju’s property sector at least for now are: CMS and Naim Holdings through their JV company, Samalaju Properties Sdn Bhd. This is based on the fact that Samalaju Properties SB has the “first mover advantage”, as it is the only developer that has presence in Samalaju Industrial Park. It has acquired 2,344 acres of landbank in the industrial area of which 148.5 acres is rented with option to purchase to operate the Samalaju Lodge (workers camp). Going forward, Samalaju Properties SB is likely to develop the township with the concept of Samalaju Eco-Park Township. Phase 1 of the development with an estimated GDV of RM400m will involve the construction of landed residential (788 units), apartments (1078 units) and commercial (170 units). The earthworks have commenced and is targeted for completion on March 2014. The management has yet to indicate the launch date, but we think it will be as early as 1Q2014 once the earthworks have been completed.

Tanjung Manis: The SCORE’s hidden gem?

A little bit of information on Tanjung Manis. Tanjung Manis is one of the SCORE’s component. Unlike SCORE’s Samalaju which is all-about energy intensive industries, Tanjung Manis is set to be the biggest Halal Hub in the world. Originally conceptualized as a timber processing zone, Tanjung Manis has flourished into a New Township serving as one of the economic hub for the central region of Sarawak. Today, its designation as Halal Industry Hub further supplements: (i) ship building industry, (ii) agriculture and aquaculture deep sea fishing industry, (iii) a palm oil industrial cluster (POIC), (iv) an oil distribution terminal for the central region, and (v) timber-based industry. Gross land area stood at 77k ha. Tanjung Manis is targeting RM42b investment with expected Gross National Income of RM31b by 2020. This is equivalent to 3% of total nominal GNI of Sarawak. It has secured few investors mainly from Taiwan and Japan for the aquaculture industry. Location wise, it is strategically connected to the far east side with its naturally deep port facility. Connectivity infrastructure is already in place with an airport, port and road to the major town of Sibu while investors’ interest and commitment have been significant.

About STIDC. Also known as Pusaka, STIDC is a semi-government body, which was established in June 1973 under the Perbadanan Perusahaan Kemajuan Kayu Sarawak Ordinance 1973. Its incorporation was initiated following the recommendation of the Food and Agriculture Organization (FAO) of the United Nations, which conducted a comprehensive forest inventory in the state from 1968 to 1972. The function would be to stimulate by all possible means the planned expansion of wood-based industries throughout Sarawak at a role consistent with the overall interest of the economy, the availability of capital and the technical expertise and effective management of the forest resources. STIDC is also responsible for development of the Tanjung Manis Halal Hub.

Basic amenities and infrastructure will come first. According to the STIDC, in order to attract investors, STIDC has to provide basic amenities and infrastructure first. Amongst them are:

- Water supply. The existing water supply can only accommodate 7 million liter per day which is inadequate to cater the expected demand of 201.88 MLD by 2020 coming from the agricultural and aquaculture industries. Hence, Phase 1 of the development of Tanjung Manis (2011 – 2014) aims to meet the treated water needs of investors with a pipeline from Gerugu Dam in Sarikei to Tanjung Manis to provide approximately 107 million litres per day (MLD) of raw water. We understand it will be constructed soon this year which comprises additional intake stations, pump stations and treatment stations and is scheduled to be operational by 2015. Phase 2 will continue to develop infrastructure in line with existing and potential investor needs which are estimated to be an additional 90 MLD for current potential project development. In total, it is proposed to transfer as much as 250 MLD to meet the requirements of Tg Manis development.

- Access roads. We understand that more roads are to be built for further connectivity and accessibilities to the Halal Hub area. Parcel 1 of access roads (together with the retention facilities), spanning about 5km and worth about RM80m has already commenced this year. Going forward, the STIDC planned to build another 7 parcels of access roads.

- Township. STIDC is also planning to build the new township in plot of 200.6 acres land in Tanjung Manis to cater for the expected higher population in the foreseeable future. It plans to build 2660 units of homes ranging from low-cost flats to semi-detached and detached houses. It has completed 192 units, mainly built by Naim Holdings.

Brunei: Slowly but steady…

Brunei: Slowly but steady. We came away from Brunei with a NEUTRAL view on the country’s construction sector. Unlike Malaysia, the country is in no hurry to build mega projects given its less-populated demographic (i.e. 400k) profile. Nonetheless, we understand that the Brunei government is slowly developing the country by improving the infrastructures and increasing number of homes. It is also good to know that the Malaysia contractors namely Bina Puri, UEM and TRC are recognized as capable contractors in Brunei. We understand Bina Puri is eyeing for some projects in the country i.e. Ministry Of Finance building and bridges.

Risks and Challenges

Our economist is of the view that apart from external shocks, the other main challenge for Sarawak to achieve higher economic growth would be the inability of the domestic economy to fully optimise its human capital potential and rich natural resources. With a population of just two million, Sarawak is under populated and is in real need to invest and develop industries that are value-added and capital intensive. Meanwhile, income distribution within Sarawak has been an ongoing issue, mainly due to the historically uneven spread of the population between urban and rural areas. The relatively higher unemployment rate and brain drain of highly-skilled and qualified locals seems to compound the problem. At an estimated 4.5% in 2011 it is much higher compared to the national average of around 3.3%. This means that it needs to step up its decade-long effort of economic diversification and population migration into more concentrated growth areas to bridge the income gap between the rural majority and the urban population.

Sectors calls and Company Specifics

Maintain OVERWEIGHT. All in, after the tight 4-day trip, we returned home with a POSITIVE feeling about the on-going development in Sarawak particularly in the SCORE areas that we visited, namely Samalaju and Tanjung Manis. As for Brunei, we are of the view that although the country’s construction sector is growing in a slower pace, this would benefits Malaysian contractors that have presence in the country i.e. Bina Puri, TRC and UEM, over the long-term.

In conclusion, with the continued progress in Sarawak’s SCORE, we believe it will continue to benefit the state’s infrastructure companies such as CMS, HSL, Naim Holdings, Bintulu Port, KKB Engineering, and Sarawak Cable in the near-long term. Maintain OVERWEIGHT on the Construction sector.

Cahya Mata Sarawak: Fresh catalyst to emerge soon?

We met the CEO of CMS, Datuk Richard Curtis and the CFO, Tuan Syed Hizam Alsagoff. We also attended a short briefing with its cement division, CMS Cement Sdn Bhd management after the meeting. Amongst the key takeaways from the meeting with the CMS Group and CMS Cement management are as follows:

To participate in another SCORE investment? After successfully executing the project with OM Holdings for the silicon plant, CMS is set to secure other investment with another investor in Samalaju, namely Malaysia Phosphalte Additives (MPA). We understand that it is currently in the final negotiation with the investor to sign the term sheet for the Power Purchase Agreement (PPA).

Road concessions to be renewed? CMS currently holds concessions of maintaining almost all state roads (appx: 4800km) and half of federal roads (appx: 680km) in Sarawak. The concessions will end 2017 – 2018. We understand that CMS is currently lobbying to renew the concessions. We believe CMS is highly likely to renew its concessions as (i) CMS has ample resources (i.e. it has invested a lot in sophisticated road equipments from Germany), (ii) familiarity with Sarawak roads being the incumbent maintainer, and (iii) its road and maintenance team are experienced, having worked for the division for the past 20 years.

Newly upgraded clinker plant is ready to blast! We understand that CMS has recently completed its upgrading works for its clinker plant. We believe this will translate into higher earnings as we understand from the management that, the energy costs (big chunk of the total cost) will likely be reduced. Even with upgrading works, CMS still managed to deliver decent pre-tax profit of RM45m in 1H13 as compared to RM39m in 1H12. Hence, we believe from FY14 onwards, its cement division will have better profitability due to efficiency after the clinker plant upgrade.

CMS is preliminarily valued at RM7.44 based on 20%-discount of our SOP. Other fresh re-rating catalysts are: (i) launching of the new Samalaju Township in Samalaju Industrial Park, and (ii) agreement with one of the SCORE project, the Malaysian Phosphalte Additives (MPA). NOT RATED.

Hock Seng Lee: A major marine-related contractor

HSL meeting and Kuching Centralised Wastewater site visit. We like HSL on the fact that it is a major construction player in Sarawak with expertise in marine-related scope of jobs. In fact, it is the biggest marine-related contractor in Sarawak. It also has strong financials with clean balance sheet (15% net margin and zero borrowings). Key takeaways from the meeting and the site visit are as follows:

The water specialist. HSL completed the RM452m Kuching Centralised Wastewater treatment plant recently and is currently preparing for full-commissioning. It is eyeing the Phase 2 of the treatment plant now which it has already proposed to the government for approval. Based on management guidance, the package 2 is worth between RM500m – RM1.0b. It is highly likely that HSL will win the project due to its expertise, resources, capacity, and track record. Timing wise, we do not think the project will be built in the near term (3 – 6 months), as it is not a “high priority” project. We think the earliest that the Government will announce the Phase 2 of the treatment plant will be in 2H14.

Having presence all over Sarawak and SCORE areas thanks to its flexibility and resources. Being a big contractor in Sarawak, HSL is everywhere in the state. More importantly, it has “significant” presence in SCORE areas (i.e. Samalaju, Mukah, Tanjung Manis). Interestingly, in Tanjung Manis, the owner and developer of the project, STIDC regards HSL as a capable contractor. In fact, almost 80% of the infrastructure-related projects in Tanjung Manis have been dished out to HSL. HSL can undertake various scopes of projects. It has expertise in 3 important segments of construction space i.e. building, infrastructure (water-related, bridges, highways) and basic amenities (roads, school, hospitals). As of now, they have about RM1.2b outstanding orderbook.

Strong financials and valuation. We like the fact that HSL has a very clean balance sheet with no borrowings and net cash balance of RM176.0m (32 sen/share). Profitability-wise, HSL is one of the highest margin achievers amongst all contractors in Malaysia thanks to its resources and ability to undertake highly complex engineering jobs which command higher margin. Meanwhile, as for its valuation, if we were to value the stock based on its 5-year historical mean of 11x on FY14EPS (consensus), the stock could be valued at RM2.22. NOT RATED.

Naim Holdings: Sarawak’s prime property developer

Bintulu Paragon site visit. On the same day in Samalaju, we managed to stop by at Bintulu City to meet Naim Holdings management who briefed us on its project in Bintulu’s prime area, Bintulu Old Airport City. Amongst the key takeaways from the briefing are as follows:

Bintulu Paragon is strategically located in the center of Bintulu City and about 60 km away from the Samalaju industrial area. The land size is 36 acres and it is one of Naim’s prime land bank with a total GDV of RM2.0b. The land is earmarked for mixed development and is set to be developed over the next five years. Phase 1A has already launched since earlier this year which comprise service apartment (SoHo) and street mall with an estimated GDV of RM400m and is expected to be completed in the next 3 years. The service apartment is 50% taken up as at October 2013. Meanwhile, its street mall has started to gain traction, receiving lots of enquiries mainly from F&B companies. The construction of the Phase 1A has already started with initial works (i.e. land clearance, earthworks, piling) already almost completed.

Maintain OUTPERFORM with unchanged TP of RM4.45. We are leaving our forecasts unchanged after the visit. We expect the Bintulu Paragon project to start contributing significantly from 2015 onwards. We appreciate Naim as one of the established Sarawak-based contractor-cum developers where: (i) it is able to achieve strong orders which exceeded our expectations (i.e. >RM500m annually), (ii) it has strategically located property developments in Sarawak (i.e. Miri and Bintulu city) with outstanding GDV of more than RM3.0b for the next 5-7 years, and (iii) Naim’s direct exposure in robust O&G sector via a 33.7% stake in Dayang Enterprise.

Bintulu Port: More clarity on Samalaju Port

Bintulu Port management meeting and Samalaju Port site visit. We met Bintulu Port management and have a short visit in the Samalaju Port site. We are POSITIVE after the visit. Amongst the key takeaways from the meeting and site visit are:

We understand that Bintulu Port’s concession for Samalaju Industrial Port will have tenure of 40 years from the operational date with the option to extend for another 20 years and it will be wholly-owned by Bintulu Port. For now, the confirmed phases of the Samalaju port will be the Interim phase (expected to be completed in 1QCY14 and is forecasted to be c.4mt pa of berth capacity) and Phase 1 (expected in 3QCY16 and be c.14mt per annum.) Ultimately, Phase 1 of the project is expected to have a berth capacity of c.18mtpa. However, the target completion date of Phase 1 is set to be in 2QCY16, which is later than we expected in our previous report (end of 2015). Further phases are expected to only be developed in the future, upon certainty of the demand and need for additional port facilities. These phases could potentially increase Samalaju Port’s total capacity from 18mtpa to 46mtpa in the long run, indicating more room for capacity expansions for sustainable growth.

With a total expected cost of RM1.8b for the two phases mentioned above, RM500m is expected to come from government grant and the remaining will be funded by equity (RM600m) and sukuk issuance (RM950). We believe that this is a sensible move given that Bintulu is a net cash company and Samalaju Port is expected to be generating steady cash flows for the company. However, we are maintaining our forecasts for now given that it is premature to speculate on the potential earnings of Samalaju port due to the uncertainty in timeline of financing of the project and minimal earnings impact expected from the Interim Phase to Bintulu Ports’ bottom-line for FY13 and FY14. Therefore, we maintain our Underperform recommendation with an unchanged Target Price of RM7.05 based on DCF-derived valuation with 6.3% WACC assumed. Risks to our call include: (i) faster than expected progress of Interim Phase and Phase 1, (ii) higher than expected earnings contribution from Interim Phase in FY13 and FY14.

Bina Puri: Strong presence in Brunei

Brunei’s Bina Puri meeting and site visits. On our last day of the trip, we went to Brunei to meet Bina Puri management and have a short tour to some of its projects. We came away from the country with a NEUTRAL view on the overall country’s construction sector. Amongst the key takeaways from the meeting and the site visits are:

Slowly but steady. Unlike Malaysia, the country is not in a hurry to build mega projects due to its under-populated demographic profile (i.e. 400k). Nonetheless, we understand that the Brunei government is slowly developing the country by improving the infrastructure and increasing the number of homes.

Bina Puri has strong presence in Brunei. The Company has already been there for about 6-7 years and it is recognized as one of the capable contractors in Brunei. Recently it built 520 homes for the Brunei government. We believe it managed to clinch the project after it successfully completed 2000 units of homes in Brunei in 2009 in only 24 months. Bina Puri also ventured into Public-Private-Partnership (PPP) in Brunei. It signed an agreement with the government where the latter lease 72 units of 3 blocks for 20 years with certain rate every quarter and in return Bina Puri has to redevelop, refurbish and upgrade the apartments. This is a great recurring income for Bina Puri which we understand that all 72 units are fully occupied. They are charging the customers at BND1200 – BND1800 per month which the built-up area ranging from 3000 – 3100 sq ft and it is fully furnished with “high-end condo” concept. NOT RATED. 

Source: Kenanga