IJM will not make any cash advances to PESTECH (Not Rated), nor provide any form of guarantee to PESTECH’s debt obligations. PESTECH will operate independently but IJM, being its single largest shareholder post-subscription of new PESTECH shares, will ask for up to two board seats. We maintain our forecasts, TP of RM1.67 and MARKET PERFORM call.

The key takeaways from IJM’s analyst briefing yesterday pertaining to the subscription of a 44.8% stake in PESTECH for RM124m cash are as follows:

1. Save for the RM124m for the share subscription, IJM will not make any cash advances to PESTECH, nor provide any form of guarantee to its debt obligations. PESTECH will operate independently but IJM, being its single largest shareholder after the exercise, will ask for up to two board seats. IJM will fortify governance and risk management in PESTECH.

2. PESTECH fits very well within IJM’s regional expansion plans. The combined competencies in civil engineering (IJM) and rail electrification and signalling (PESTECH) will enable the new alliance to bid for large rail projects in both local and international markets.

3. With PESTECH’s EPCC track record for high-voltage electrical transmission lines local and regionally, there is opportunity for IJM to tap into the rapid growth of electricity demand and integration of Southeast Asia’s power grid system which requires upgrade of power grids projected at USD1.2t until 2040. PESTECH already has a strong presence in Cambodia which is one of the fast growing energy infrastructure development countries in ASEAN.

4. PESTECH’s projects typically command higher margins (than IJM’s civil jobs) as they are highly specialised. PESTECH also generates recurring sales from the same customers, providing after-sales services such as maintenance.

5. As at end-Mar 2023, PESTECH’s net debt and net gearing stood at RM1.21b and 2.32x respectively. However, we are unperturbed as the debt is backed by trade receivables and contract assets of RM1.8b. While its projects in Cambodia are executed on a deferred payment basis, the paymaster is national utility company Electricite du Cambodge and the payments are denominated in USD. Upon the completion of IJM’s share subscription, PESTECH’s net debt and net gearing will improve to RM1.09b and 1.68x respectively.

6. PESTECH expects to record RM500m revenue in FY23 (FYE Jun) before recovering to pre-COVID levels of RM700m-RM800m in FY24 and FY25. Its typical net profit margin was 8%-10% during the pre-pandemic period but forward margin could be lower given the elevated raw material prices.

We reiterate our positive view on the acquisition as it will strengthen IJM’s construction value chain to include EPCC for high-voltage electrical transmission lines, as well as rail electrification and signalling. It gives IJM an immediate presence in the rail electrification space. PESTECH has completed prominent projects such as the Klang Valley Double-Tracking and MRT2. It is currently working on two key projects, i.e., KLIA’s aerotrain and the Rapid Transit System between Johor Bahru and Singapore.

With such strategic tie-ups together with its extensive track record in the construction of railway development, IJM will be able to strengthen and widen its potential roles in impending mega rail projects such as the MRT3, Penang LRT and KL-Singapore high-speed rail. Financially, the RM124m capital outlay will raise IJM’s net debt and net gearing of RM2.51b and 0.26x as at end-Mar 2023 to RM2.63b and 0.27x respectively that are still highly manageable.

Forecasts: Maintained.

We maintain our SoP-driven TP of RM1.67 (see below) on unchanged 13x PER valuation for its construction business, at a discount to the 16x-18x we ascribe to its peers to reflect IJM’s higher exposure in the office building segment which is weighed down by an oversupply situation. There is no adjustment to our TP based on ESG given a 3-star rating as appraised by us (see Page 4).

We continue to like IJM for: (i) the improved outlook of the construction sector with the imminent rollout of public infrastructure projects, (ii) its strong earnings visibility underpinned by an outstanding construction order book of RM5.1b, and (iii) Kuantan Port’s position as the largest port in the east coast capturing export and import activities growth. However, we remain cautious over the restructuring of Besraya and its loss-making toll roads namely the West Coast Expressway (WCE) and Kajang-Seremban Highway (also known as Lekas) due to low traffic volumes. Maintain MARKET PERFORM.

Risks to our call include: (i) sustained weak construction job flow, (ii) project cost overruns and liabilities arising from liquidated ascertained damages (LAD), and (iii) rising cost of building materials.

Source: Kenanga Research - 26 Jul 2023