We initiate coverage on Sunway Construction Group (SUNCON) with an OUTPERFORM rating and Target Price (TP) of RM1.81 based on SoP which implies FY17E PER of 15.7x. Investment merits include: (i) its well-integrated construction setup, (ii) healthy orderbook of RM5.0b with 2-3 years’ visibility, (iii) major a beneficiary of infrastructure play, (iv) well-supported by parent company, (v) reputable pre-cast division benefiting from Singapore public housing, (vi) dividend policy of 35% DPR with more potential upside, and (vii) strong balance sheet with net cash position.

A One-stop Contractor. We like the fact that SUNCON is a well-integrated construction company offering a wide range of construction services, which allows them to offer full package of construction services to their clients, which makes them more competitive among their peers. Furthermore, it does not carry other business risks i.e. property or plantation as compared to other big-cap contractors.

Riding on infrastructure boom. As SUNCON possesses excellent track records in three major urban public transport projects, namely LRT, MRT and BRT, we are confident that SUNCON will continue to benefit from infrastructure projects under 11MP. For 2016, we expect SUNCON to bag LRT3 and stand a high chance in the Pan Borneo highway after securing RM1.2b in MRT2 project earlier this year. That said, we also understand that the government is planning to implement the 34km KL-Klang BRT Corridor to ease the traffic congestion; while there are no specific timeline for the execution for this particular project, we believe SUNCON will stand out from the other contractors in terms of bidding, due to their excellent track record in the Sunway-USJ BRT Line.

Strong orderbook of RM5.0b, and more to come. As at end-1Q16, SUNCON’s outstanding orderbook stands at RM5.0b with a replenishment potential up to RM6.0b-RM7.0b. This provides earnings visibility for next 2-3 years. Out of the RM5.0b, 26% is from infrastructure, 38% external building related jobs, 28% from its parent SUNWAY, and 8% from pre-cast division. In terms of replenishment, the group has already secured approximately RM1.9b worth of new orders to date. We are confident that it will easily achieve RM2.9b new wins in FY16, as we are anticipating SUNCON to bag LRT3 which we estimate to be worth approximately RM1.0b. Hence, we believe that SUNCON should be able to surpass our FY16E replenishment target of RM2.9b which would allow them to maintain their outstanding orderbook at a steady level of c.RM5.5b by year end.

Precast division, one of the key drivers. Currently, its precast division only contributes 8% to its total the group’s outstanding orderbook of RM5.0b. However, in terms of profit contribution, it made up 55% of the group’s FY15 pretax profit of RM140.8m. Management expects the orderbook to continue to sustain at this current level, i.e. RM300-400m every year, driven by resilient precast concrete products demand in Singapore that is largely used for public housing schemes which we believe will continue to be SUNCON’s core earnings driver.

Steady earnings growth of 5%-12% with minimum DPR of 35%. Current orderbook size of RM5.0b provides SUNCON earnings visibility of 2-3 years and we are estimating net profit of RM133.5m-RM149.6m for FY16-17E, which represents growth of 5-%-12%. At a minimum DPR of 35%, we are looking at DPS of 3.6sen and 4.1sen which implies yields of 2.3-2.5% for FY16-17E. However, we believe that there is more upside to its dividend as they are able to raise their dividend pay-out ratio higher due to minimum CAPEX requirements. To recap, SUNCON paid out a total dividend of 4.0sen previously, which represents 40% of profit for FY15.

Valuation. Currently, SUNCON is trading at FY17E PER of 13.7x, representing 17% discount to big-cap peers’ (IJM, GAMUDA, WCT and MMC) average of 16.4x. Our SoP-based TP of RM1.81 implies FY17 PER of 15.7x, which is still below its big-cap peers’ average of 16.4x. We believe it is justified given their strong job flows and light balance sheet as compared to the big-cap peers. Furthermore, it is also below our targeted PER of 16.0x-18.0x for the big-cap players.

Source: Kenanga Research - 30 Jun 2016