9M18 CNP of RM104.9m is within our but below consensus expectations, at 70% and 67%, respectively, due to: (i) lower-than-expected construction billings, and (ii) a relatively weak pre-cast division due to stiff competition and high steel prices. No dividend as expected. Lowered FY18-19E CNPs by 7-23%. Downgrade to UNDERPERFORM with a lower TP of RM1.30 (previously MP, TP: RM1.65).

Within our expectation, below consensus’. 9M18 CNP of RM104.9m came in within our expectation but fell short of consensus’, making up 70% and 67% of our and consensus full-year estimates, respectively. We believe that the negative variance could stem from several reasons, i.e. (i) slow progress on certain projects like LRT3, and (ii) weak performance from its pre-cast division due to higher cost structure and stiff competition. No dividends proposed in 3Q18, but year-to-date dividends declared of 3.5 seen are on track to meet our expectation of 7.0 sen.

Results highlight. For 9M18, SUNCON registered decent revenue growth of 23%, YoY, mainly driven by its construction division. However, 9M18 CNP growth was marginal at only 3% as they experienced margin compression where pre-tax margin fell from 10% to 8%, coupled with the higher effective tax rate of 20% (+1ppt). The contraction in margin was mainly from its pre-cast division, which saw pre-tax margin compressed from 20.7% to 3.8% due to higher steel bar prices compared to tender price as steel content contributed to approximately 40% of its total cost coupled with stiff pricing competition. QoQ, 3Q18 CNP grew 7% albeit with a flattish revenue growth of 2% thanks to the improvements in construction pre-tax margin of 9.3% (+0.9ppt) due to finalisation of an account of certain completed projects. However, its pre-cast division registered pre-tax loss of RM1.9m vis-à- vis pre-tax profit of RM2.3m in 2Q18 due to high steel bar prices due to higher steel bar content needed for its current projects.

Outlook. The sector outlook is less aspiring due to the recent government review of spending on infrastructure jobs. We believe strong players like SUNCON are able to weather through these challenging times given their strong parent (SUNWAY) supported by decent outstanding order-book of c.RM5.6b with 3-year visibility. However, we note that LRT3 still makes up c.36% of its total outstanding order-book as the outstanding work from this particular project remains relatively high at RM2.0b as the project was put on hold for a cost review by the government. In the medium term from year 2020 and beyond, SUNCON might consider participating in overseas projects, i.e. in Myanmar and India.

Earnings downgrade. Post results, we take the opportunity to update our project recognition timeline by rescheduling the completion date for LRT3 and lowered or margin assumptions for its pre-cast division, which subsequently lowered our FY18-19E CNPs by 7-23%.

Downgrade to UNDERPERFORM. Following our downward earnings revision, our SoP-driven Target Price is also lowered to RM1.30 (previously, RM1.65). As a result, we downgrade SUNCON from MARKET PERFORM to UNDERPERFORM. Our TP of RM1.30 implies 12.5x FY19E PER which is at a higher range of our ascribed multiple of 11.0x for the sector.

Risks to our call include: (i) higher-than-expected margins/order-book replenishment, and (ii) higher government spending on infrastructure and affordable housing projects.

Source: Kenanga Research - 21 Nov 2018