We believe that Bandar Malaysia could provide a pipeline of works for local contractors over the long term. However, we are unexcited for the time being as we expect construction contracts to be awarded earliest by end-2020 if not 2021, should IWH-CREC is able to complete their acquisition of the 60% stake in Bandar Malaysia this year. Now that the two major news-flow i.e. ECRL and Bandar Malaysia are out, we are taking the opportunity to downgrade our NEUTRAL call to UNDERWEIGHT. We opine that investors should take this opportunity to sell on strength prior to May 2019 results reporting season. We do not rule out that the upcoming results season may have higher rate of disappointments due to the compression of margins in the construction sector, while infrastructure contract awards may take longer than expected to be awarded. Furthermore, we could be seeing more cash call exercises in the construction space in the future, as contractors may need to raise fund from the market for working capital needs or to undertake public-private partnership related projects.

Bandar Malaysia, a prime cut. Last week, it was reported that the government is looking to revive the Bandar Malaysia deal with IWH-CREC (60:40) joint-venture. IWH-CREC is required to make an additional payment of RM500.0m in 60 days’ time. The RM500.0m is on top of its original deposit sum of RM741.0m that was agreed back in 2017 prior to the cancellation, bringing the total deposit amount to RM1,241.0m for the 60% stake in Bandar Malaysia. In terms of its size and location, Bandar Malaysia (486 acres) could be one of the last largest parcel of prime land in the heart of Kuala Lumpur.

IWH-CREC acquisition cost. Tracking back to 2017, the initial acquisition cost for 60% of Bandar Malaysia translate to RM7.4b (RM583.4psf) and IWH-CREC was required to fork out a 10% deposit of RM741.0m. However, there was no mention on IWHCREC’s total acquisition cost during the recent revival of the Bandar Malaysia project. So, should we assume that the deposit sum of RM1,241.0m represents 10% of the total cost for the 60% stake in Bandar Malaysia, IWH-CREC’s total acquisition cost for Bandar Malaysia could come up to RM12.4b. As such, Bandar Malaysia at 100% stake would be valued at RM20.7b, translating to RM977.0psf. Based on our assumed land cost of RM20.7b and the Prime Minister’s Office (PMO)’s announced estimated GDV of RM140.0b, it implies a land cost to GDV ratio of 15%, which we deem to be fair. In terms of pricing psf, it is much lower compared to TRX, which was transacted at RM2,704.6psf back in 2015, which we believe to be a good deal for IWH-CREC. Currently, Bandar Malaysia is 100% owned by Ministry of Finance (MOF).

Funding - the devil is in the details. While we believe that it is a good deal for IWH-CREC, the funding plan for the remaining 90% or RM11.2b remains unclear. Based on IWH-CREC joint-venture structure of 60:40, IWH and CREC would need to fork out RM6.7b and RM4.5b, respectively. We are not sure if it is a bullet payment upon fulfilment of condition precedent or a scheduled payment over a specific number of years. Should it be a bullet payment, we opine that IWH would need to raise bank borrowings to fund its portion of RM6.7b for the land deal. Based on its FY17 financial statements acquired from SSM, IWH registered revenue of RM352.8m and losses after tax of RM90.3m. While we do not have the breakdown of its bank borrowings, we estimate its gross gearing to hover around 0.5-0.7x should we assume that its borrowings make up 50-60% of its total liability. Based on our assumptions above, we reckon that IWH could potentially raise RM2.0b of bank borrowings should they bring their gross gearing up to 1.0x. This means that IWH might need to look for alternative funding for the remaining RM4.7b.

Alternative funding sources. IWH’s sister companies i.e. IWCITY and EKOVEST have made announcements that they are not involved in Bandar Malaysia. However, given that IWH is a private limited company, the choices for alternative funding for the remaining RM4.7b could be limited. We reckon that it is high likely that IWH would need to look for funding from new investors, which might potentially reactivate a rationalisation and restructuring exercise which IWH explored back in 2017 that involved IWCITY. Hence, we do not rule out a mega restructuring exercise that could potentially involve its sister companies – IWCITY, EKOVEST, PLS and KNUSFORD in the future. Should IWH reactivate their rationalisation and restructuring exercise, we believe it could take up to 9-12 months for them to complete the acquisition for the 60% stake in Bandar Malaysia. To recap, IWH’s sister company EKOVEST recently proposed to undertake private placement of up to 10% of its issued shares to raise fund for its development working capital needs. Alternatively, IWH-CREC may potentially consider diluting its stake to other potential interested players if they are not able to secure funding options.

A mega developer in making? If IWH-CREC is successful in acquiring the 60%-stake in Bandar Malaysia, we opine that they could take on the development on their own or subdivide Bandar Malaysia into multiple parcels and dispose to interested developers. We opine that it is essential for IWH-CREC to do outright sale of subdivided Bandar Malaysia lands to interested developers, as it is essential to fund the entire infrastructure of Bandar Malaysia without any funding from MOF. Also, EKOVEST could potentially be Bandar Malaysia’s key contractor. Should IWH-CREC sell an infrastructure-ready land to interested developers, they could be one of the very few master developers in Malaysia that undertake such massive project similar to the Kwasa Damansara development undertaken by Kwasa Land Sdn Bhd, a wholly-owned subsidiary of EPF. One of the key benefits of selling infrastructure-ready land is that they would be able to command a premium pricing over undeveloped land. However, it could be a strain on IWH-CREC’s balance sheet as it would require a huge amount of working capital to kick start infrastructure works in Bandar Malaysia.

Bandar Malaysia’s infrastructure works, a boon for contractors? Typically, Gross Development Cost (GDC) makes up c.50% of total Gross Development Value (GDV) of a project, indicating that the total GDC for Bandar Malaysia could hover at c.RM70.0b, based on the estimated GDV of RM140.0b announced by PMO. Assuming infrastructure makes up 10-15% of the total GDC, IWH-CREC might need to fork out another RM7.0-10.5b for Bandar Malaysia’s infrastructure works. Should we assume 40% local participation, we believe that local contractors can be eyeing RM2.8-4.2b amount of infrastructure works from Bandar Malaysia earliest by end 2020. Subsequently, they can bid from individual developers participating in Bandar Malaysia just like IJM which tendered for HSBC tower works in TRX. Hence, we believe that the construction works for the development in Bandar Malaysia could commence earliest by 2023-2024. Nonetheless, our concern lies with the funding for the infrastructure works as IWH-CREC might need to do another round of fund raising, unless they are able to sell the land before commencing on any infrastructure works. There has been some euphoria in the market with the KLCON index sharply rebounding by 47.7% over 4 months since its low in December. We believe it would be short-lived given the uncertain timeline of the development of Bandar Malaysia. Hence, we are less enthusiastic with the potential prospects it presents for the local contractors in the near to medium term. We also believe the coming quarters would be met with earnings risks while contract news-flow may take longer to materialize.

Downgrade to UNDERWEIGHT from NEUTRAL. Currently, KLCON is trading at 1-year Fwd. PER of 12.8x, close to its 10-year average of 13.3x, after staging a strong expansion in valuation of 68.4% from its weakest level of 7.6x (-3.0SD to the 10-year average). In terms of share price performance for all the stocks within our coverage, they also staged a fantastic rebound registering year-to-date gain of 0.7-60.3% except for SENDAI, thanks to the news-flow on ECRL and Bandar Malaysia. We expect the upcoming results season to see higher rate of earnings disappointments due to the compression of margins in the construction sector. Furthermore, we could be seeing more cash call exercise in the construction space in the future, as contractors might need to raise fund from the market for working capital needs or to undertake public-private partnership related projects. Hence, we believe the recent share price euphoria presents a good opportunity for investors to take profit as we prefer lower entry levels. While we have rolled forward our valuation base year to FY20E for all of the stock under our coverage, there are minimal changes to our Target Prices and Calls due to their flattish earnings growth, except for KIMLUN which we upgraded its Target Price from RM1.30 to RM1.35, while we downgraded MITRA’s Target Price from RM0.260 to RM0.245. (Refer overleaf for more details). Stocks that are UNDERPERFORM constituted 7 out of 11 stocks within our coverage, as follows: GAMUDA, GKENT, HSL, IJM, MITRA, SUNCON and WCT, which we believe that investors can start with the one with highest year-to-date return. (Refer overleaf for more details). As for OUTPERFORM call, we only have MUHIBAH while the rest (SENDAI, HSL, KIMLUN) are at MARKET PERFORM. As for stocks like GKENT, we may look to review our call and Target Price in the near future.

Source: Kenanga Research - 30 Apr 2019