Yesterday, MOF announced that they are terminating GAMUDA-MMC JV as the main contractor for the tunnelling works. Negatively surprised, we reduced FY19-20E earnings by 33-32%. Downgrade to MP, with a lower SoP-driven TP of RM3.25 (previously, OP; TP: RM4.30). Our TP implies FY19E PER of 14.3x above KLCON’s 5-year average of 13.4x, which we believe to be fairly valued. Following our downgrade in earnings, call and TP, GAMUDA is no longer our Top Pick for 4Q18.

News. Yesterday, the Ministry of Finance (MOF) announced that they are terminating GAMUDA-MMC JV as the main contractor for the MRT2 tunnelling works valued at RM16.7b. Recall that the JV was awarded the contract back in 2016. For the remaining c.70% works, the government will call for an international tender to participate in the project.

Negatively surprised. The news is a negative shock to us as we never expected the government to terminate this contract as a termination might result in a hefty compensation to the contractors. However, we are unable to confirm on the potential compensation; further details still pending from management.

Hoping for the best. While we believe that international parties could be interested to participate in the tendering process for the remaining works, we believe that GAMUDA-MMC JV would still have an edge over potential bidders given that their machineries are already in place coupled with their strong track record in dealing with the underground rock formation in Kuala Lumpur due to their past experience with MRT1 and SMART Tunnel. Furthermore, GAMUDA-MMC JV had set up the Tunneling Training Academy (TTA) and the TBM Refurbishment Plant; both substantial investments for sustainable human capital, which they are expecting to have 1,000 skilled Malaysian tunnel workers by the end of MRT2 tunneling works.

Outlook clouded by more uncertainties. After factoring this termination of MRT2 tunneling works, its outstanding order-book will be significantly reduced to c.RM0.5b from RM6.0b, with its outlook highly dependent on its property division (property unbilled sales of RM2.3b which provide 1-2 years of visibility) and its infrastructure division, which consists of toll roads.

Earnings cut. We slashed our FY19-20E earnings down by 33-32% as we removed the tunneling portion of MRT2 from our earnings model while reducing our margin assumptions for the elevated portion from 6% to 4%.

Downgrade to MARKET PERFORM. Following the unexpected termination of MRT2 tunneling works, we downgrade GAMUDA to MARKET PERFORM (previously, OUTPERFORM and Top Pick) as we lowered our SoP-driven Target Price to RM3.25 (previously, RM4.30) after factoring the loss of MRT2 tunneling works coupled with a lower 10.0x FY19E PER ascribed to its construction division (previously 14.0x). Our TP implies FY19E PER of 14.3x above KLCON’s 5-year average of 13.4x, which we believe to be fairly valued. Following our downgrade in earnings, call and TP, GAMUDA is no longer our Top Pick for 4Q18.

Risks to our call include: (i) cancellation of toll concessions, and (ii) higher-than-expected input costs, and (iii) lower-than-expected property sales.

Source: Kenanga Research - 08 Oct 2018