INVESTMENT HIGHLIGHTS

• Based on a statement by MoF, MMC-Gamuda underground work contract has been terminated

• A negative surprise to orderbook and earnings

• JV Co participation in new tendering bid is conceivable

• 23% reduction of turnkey contract value

• Cut TP to RM2.78 but upgrade to BUY pursuant to recent selloff

Termination of MMC-Gamuda underground work contract. Recall that MoF has been pushing for further cost reduction in public infrastructure spending, as it works towards improving the government’s fiscal standing. Based on a statement by MoF, the contract cancellation of MRT2 ground work portion came after the failure to make further reduction in costs, as what was desired by the new government. Following this development, we reckon the financial impact to MMCGamuda JV Co would be negative.

MMC-Gamuda’s media statement on the contract termination. We understand from a press statement made by the JV Co that they have yet to receive neither communication nor notification from MRT Corp, the counter party to the award of the Project. Practically, there has been no official confirmation from MRT Corp that MMC Gamuda has been terminated as the underground contractor.

The underground portion of MRT2 contract carries an outstanding orderbook value of RM5.6b, with project completion spans until May 2022. We are expecting about 8%-11% of potential earnings reduction for every quarter in FY19/20/21/22 to the tune of 24.0m-26.0m. Cumulatively, this accounted for 11% and 13% of our and consensus full year 2019 estimates.

Impact from changes to turnkey contract. On top of this, we understand that the above-ground contract value has been reduced by 23%, with the JV’s previous role as a PDP has now switched to a turnkey contractor. Based on the new remaining contract value of RM4.4b, we are estimating a full year net profit contribution of RM55.0m to Gamuda. It is notable that this is a reduction of -29.9% from the previous contract.

Would there be a second chance for the JV Co? We are not ruling out the possibility of Gamuda and MMC to participate in the retendering process, if an agreement is reached. Assuming that both entities are able to reduce cost, we believe the outcome will be positive. This is taking into consideration the JV Co initial involvement in the project and the competitive cost advantage it is able to achieve, in comparison to potential tender bids by other contractors.

Despite the changes agreed for the above-ground contract value, the entirety of its outcome to Gamuda is still uncertain subsequent to the news on the contract termination. This is considering the lack of official confirmation from MRT Corp to MMC-Gamuda JV Co since the news broke. On this occasion, we adopt a conservative view hence we decided to revise our forward valuation on the stock.

Our recommendation. Given the change in valuation, we lowered our TP to RM2.78, pegging its FY20 EPS to PE of 11x. Note that our valuation methodology has switched from SOP to PE multiples, as we make allowance for the current market sentiment on the sector. We believe that forward PE can better reflect its fair value in the short to medium term, as uncertainties remain on the horizon. Consequent to the slump in Gamuda’s stock price yesterday, our adjusted TP currently constitutes a BUY call. Accordingly, we believe the weakness of the stock price should be viewed as an opportunity for investors to take position.

Shedding light on its business prospect. Overall, we are still upbeat on Gamuda’s earnings growth prospect based on its strong orderbook and healthy contribution in the property segment. On the property segment, we remain optimistic on its medium term outlook predicated on 1) the completion of construction works at 661 Chapel Street, Australia, and 2) potential of better take-up rates in the domestic market.

Source: MIDF Research - 9 Oct 2018