We like George Kent (M) Berhad (GKENT) for its niche business in the construction space specialising in M&E and system related works, which propelled them to be one of the preferred rail-related contractors in recent years given their role in LRT2 and LRT3. Looking ahead, we are projecting an impressive earnings growth trajectory of 26-58% for FY17-18E backed by existing order book, and we also like them for their strong net cash position and consistent dividend pay-out >40% (FY17E yield; 3.6%). Hence, we have a TRADING BUY call on GKENT with a Sum-of-Parts (SoP)-driven Target Price of RM2.71.

It all begins with LRT2 system works. From an investment perspective, GKENT should be repositioned as a construction player, although most investors still regard them as a water meter manufacturer rather than a construction player. GKENT came into the limelight when they first bagged the c.RM1.0b system works for LRT2 in 2012 and they faced much scepticism on their ability in executing such mega projects back then. However, prior to their foray into rail infrastructure, GKENT was already actively involved with system works in the water industry. Strong projects execution enabled them in growing its construction division over the past four years with construction profits making up an average c.68% of pre-tax profits. That said, their pre-tax margins for their construction division have been fairly decent at an average of 11% over the past four years, which have improved from 7% to 14% from FY13 to FY16, which is comparable with mid-cap players such as MITRA, GADANG and KERJAYA.

Continued with LRT3 PDP role… Last year, along with their JV partner MRCB. GKENT has successfully bagged a bigger role in the rail infrastructure scene, as the PDP for LRT3 with an estimated cost of RM9.0b due to their strong execution track record for LRT2 works. Based on the 6% PDP fees, GKENT would easily register pretax profits of RM54.0m per annum. However, we reckon that there could be more upside to the initial estimated cost of RM9.0b as the final cost would only be concluded once the final tender is awarded.

Hungry for more jobs. Its outstanding order book stands at c.RM600.0m (excluding LRT3), will provide them visibility for a year. However, management indicated that they are still bidding for more jobs despite landing the PDP role for LRT3. Currently, management is eyeing at least two more hospital jobs worth c.RM700.0m, MRT2 track works worth c.RM1.0b and more water-related infrastructure projects for the replenishment of its bread and butter business.

Net cash with decent payout. Over the past five years, GKENT had been consistently paying out >40% of its net profits as dividends. Although not having a formal dividend policy, this is at a higher-end in terms of pay-out amongst contractors. We believe that with its strong net cash position of RM223.1m or RM0.74/share, GKENT is able to maintain its pay-out comfortably. At an assumed 40% pay out, we would be expecting DPS of 8.0 sen for FY17, which translates to a yield of 3.6% that is higher compared its peers (KERJAYA, MITRA, GADANG) average of 2.7%.

Exciting growth ahead! For FY17, we are only assuming a conservative order book replenishment of RM700.0m and net profit growth of 26-58% for FY17-18E. Our FY17E growth of 26% is backed by its outstanding order book of c.RM600.0m coupled with our assumptions of RM700.0m. Our growth for FY18 is substantially higher compared to FY17 as we assumed full contribution for LRT3 PDP fees in FY18. Based on channel checks, the 8 system and 12 civil packages for LRT3 are expected from 4QCY16 onwards which we believe GKENT would be able to reap the full benefits of its PDP fees upon the commencement works for LRT3.

Trading BUY! We value GKENT at RM2.71 based on SoP valuation methodology that implies a 12.8x FY17E PER. For its construction division (63% of SoP), we are only ascribing a valuation of 10.0x FY17E PER which is still below KERJAYA, GADANG and MITRA’s applied PER of 12.0-13.0x. We see additional room for further upgrades should GKENT continue to deliver earnings performance (refer overleaf for other segment details for our SoP valuation). That said, we also believe that the next re-rating catalyst for GKENT is higher construction cost for LRT3 above RM9.0b as this would further increase their profitability based on the PDP fees of 6%. Currently, it offers a dividend yield of 3.6%, which is still far superior compared to its mid-cap peers average of 2.7%.

Source: Kenanga Research - 8 Aug 2016