We were negatively surprised by Muhibah’s proposed rights issue to raise RM120m and using most of the proceeds to pare down debt; a poor allocation of capital in our view. This untimely rights announcement could also insinuate potential cash collection issues in the immediate term. While we raise FY22E earnings by 6% to account for interest savings, call is downgraded to MP (from OP) with lower SoP-TP of RM0.60 (previously RM1.25).

Proposed rights issue to potentially raise RM120m. Muhibah has proposed a 1:2 rights issue to potentially raise c.RM120m if all 242m rights are fully subscribed at the tentative price of RM0.50. Proceeds raised would be used to pare down debts (RM96.7m i.e. 80% of proceeds) while the rest will be used for working capital (RM23.3m i.e. 19%) and defray the expenses required for this exercise (RM0.9m i.e. 1%). Post exercise by 2QCY22, Muhibah’s net gearing is expected to fall to 0.35x (currently 0.50x) and there will be interest savings of RM3.0m from the reduced debt.

Unexpected rights issue. We were completely caught off guard by such an exercise to pare down debts as Muhibah’s: (i) net gearing has been trending down from its peak of 0.58x in 4QFY19 and currently stands at manageable levels of 0.50x, (ii) receivable turnover days have remained rather healthy by historical means at 292 days (vs. 5-year average of 279 days), and (iii) operating cash-flows remains positive.

Furthermore, its declining outstanding order-book in its infrastructure division (currently standing at RM300m) should technically translate to more cash upon project completion since no cash outlay is required for new project deployment. Also, the retention sums (typically 5% of contract value) to be received post-project completion should also mean healthier cash levels moving forward.

Poor use of proceeds. In a low interest rate environment, we opined that the use of equity to solely pare down debts to save on 3% interest costs is a poor allocation of capital which dilutes EPS and ROE. What’s more perplexing was that our checks with management revealed that they are comfortable with a net gearing of below 2.0x (currently only 0.5x) and there is currently no covenant that prohibits them from raising additional borrowings.

Potential cash-flows issues lurking? With so much additional debt head room (it can raise another RM1.65b before hitting the 2.0x net gearing limit), we opined that such rights exercise potentially alludes to: (i) the inability to collect receivables which could lead to cash constraints and impairments, and (ii) inability to raise additional debt to bridge funding needs.

While an acquisition could potentially be on the cards, we still feel using debt to fund such acquisitions would be a better option. Even if equity was the preferred choice for funding, it would be wiser to time the rights announcement alongside the acquisition which would clear suspicion over cash-flows issues. The unexpected rights announced during noon yesterday crashed its share price (-26.7%) which could hamper the fund raising objectives as the discount from current share price to ex-rights price has narrowed substantially (from 31% discount when cum-price was RM0.84 to 6.5% when cum-price is RM0.62). This has also reduced the overall appeal for existing shareholders to participate in the exercise.

Tweak FY22E earnings higher by 6% (+RM1.5m) to factor in the potential interest savings starting 2HCY22. Downgrade to MP (from OP) with lowered SoP Cum/Ex TP of RM0.60/0.565 (from RM1.25) after: (i) completely omitting valuations for its infrastructure division due to poor execution and potential impairments, (ii) factoring in a 25% holding discount to FAVCO, and (iii) increasing the WACC of its airports to 15% from 10%. While current share price does provide a bargain for a recovery play at its Cambodian airports, the immediate concern over this rights proposal and potential cash-flows constraint may pose as an overhang for the stock.

Risks to our call include: (i) lower-than-expected order-book replenishment target, (ii) delays in construction progress, and (iii) sharp spike in raw material costs.

Source: Kenanga Research - 11 Jan 2022