While we laud its expansion plans, we are not entirely positive with its landbanking ambitions and construction contracts being paid in kind which will further tax the group’s cash flow. We are concerned of its already high net gearing (1.12x in 2Q15) which will be further weakened to 2.27x assuming full debt funding of these deals. Thus, probability of a cash call has increased while returns from these projects will take quite a while to materialize. Due to the lack of information of its financing plan for its landbanking ambitions, we opt to place MRCB UNDER REVIEW pending further clarification from management. Our previous rating was MARKET PERFORM with an Target Price of RM1.10 that is based on -2SD historical mean Fwd P/NTA of 1.17x on FY16E NTA/share of RM0.94.

 On replenishment mode… Yesterday, MRCB made three separate announcements on BURSA related to its land banking and construction contract award replenishments in FY15 starting with: (i) proposed joint-venture on a 70:30 basis with Cyberview Sdn Bhd (CSB) to develop 53.4ac of land in Cyberjaya with its 70% stake amounting to RM269.5m, (ii) proposed privatisation agreement between its 85% owned subsidiary Rukun Juang Sdn Bhd (RJSB) and the Malaysian Government, for the refurbishment of facilities in the National Sports Complex, Bukit Jalil for a contract sum of RM1.6b, in exchange for 92.5ac (3 pieces of leasehold land) in Bukit Jalil that has a potential GDV of RM14.6b, and (iii) RM3.1b worth of construction job replenishment from Kwasa Development (1) Sdn Bhd spanning over 12 years for the proposed development and construction of a commercial project named Kwasa Utama in Kwasa Damansara.

Aspiring ambitions, funded by? While we laud management’s capabilities in securing such attractive deals i.e. landbank and construction orderbook replenishments in such short span of time, we are re-iterating our concerns on its balance sheet whereby its net gearing stands at 1.12x as of 2Q15, which is already relatively high compared to its peers that ranges between 0.30x-0.40x. Based on simple extrapolation, MRCB would have to fork out a whopping RM2.65b to fund its landbank replenishment ambitions i.e. Kwasa Damansara (RM0.7b), German Embassy Land (RM0.3b), Cyberjaya mixed development (RM0.3b), Bukit Jalil privatization agreement (RM1.3b), which would further inflate its current net gearing position of 1.12x (2Q15) to an alarming net gearing ratio of 2.27x should all of these transaction materialize.

Cash-call is imminent. The announcement of all these landbank replenishments has further reaffirmed our view that a cash call is imminent to fund these projects. Assuming MRCB need to raise RM2.65b for the funding of all these landbanks, we are looking at a potential rights issuance of 2 for every 1 share with an assumed 40% discount to its current price of RM1.19 for its rights price. Should this scenario materialize, it would have a major dilution impact on its FY16E EPS by 67%. Hence, we strongly believe that the management should address the funding options for its landbanking ambitions.

Risks… That said, looking into 2016 whereby construction jobs are abundant due to the execution of mega infrastructure projects i.e. MRT2 and LRT3, we foresee there could be a shortage of talent pool in the construction industry which will to lead higher staff costs in the next few years as contractors potentially struggle with foreign labor issues. Furthermore, given the soft property market outlook, we opine that developers could run the risk of higher holding costs for newly-acquired land as they might not be able to launch its property projects as planned. To recap, several major developers had held back launches in 2015 which resulted in a major reduction in sales target or cancellation in land acquisition.

UNDER REVIEW All-in, we are pending further clarification from management on its funding plans for all these land acquisitions. Additionally, contracts which are associated with land swap deals imply that value realization will take much longer while cash will be tied up in these assets, implying a lag in returns for shareholders. Hence, we are placing the stock UNDER REVIEW. Our previous rating was MARKET PERFORM with an Target Price of RM1.10 that is based on - 2SD historical mean Fwd P/NTA of 1.17x on FY16E NTA/share of RM0.94. No changes to our FY15-16E earnings as the orderbook replenishment of RM1.6b and RM3.1b which is staggered over 12 years are still within our FY15-16E replenishment assumptions of RM1.0b -RM1.8b, respectively. 

Source: Kenanga Research - 29 Oct 2015