We  downgrade  our  call  to  NEUTRAL  but  maintain  our  earnings forecasts  and  SOP  TP  of  MYR5.35  (3%  upside).  Gamuda  is  the  best proxy to the buoyant construction sector, given its dominant role in the MYR73bn Klang Valley MRT project. However, there is probably limited upside  to  its  share  price  as  it  has  risen  42%  since  2013.  We  expect earnings to contract by 13% in FY16 (Jul) on completion of MRT1.  

A valuation call. We downgrade Gamuda to NEUTRAL from Buy given the  limited  3%  upside  to  our  TP  of  MYR5.35.  Despite  a  general  weak equity market in Malaysia, its share price has still nudged up by 3% YTD, bringing its gains since 2013 – largely fuelled by the market’s excitement over its involvement in the Klang Valley mass rapid transit (MRT) project –  to  a  whopping  42%. We  see  a  declining  reward-versus-risk  profile  for Gamuda over the next 12 months, due to the following reasons: 

i)  the consensus estimate for its FY16 earnings is behind the curve – having erred on what we term as “the side of not listening”;  
ii)  the  rising  risk  of  Gamuda’s  property  profits  on  continued deterioration  in  the  confidence  and  sentiment  of  property  buyers  in general;
iii)  while  the  market  happily  prices  in  its  potential  gains  from  the MYR27bn  Penang  Transport  Master  Plan,  it  may  have  overlooked the “pains before gains”, including a potential cash call;
iv)  further delays in the disposal of Gamuda’s 40% stake in Splash, and
v)  the possibility of the Government eventually deferring certain public jobs on the back of the continued slump in oil and gas prices.

Forecasts.  We keep our forecasts relatively unchanged.

Downgrade  to  NEUTRAL.  We  maintain  our  SOP-based  TP  at MYR5.35.  We  value  Gamuda’s  construction  business  at  18x  1-year forward  earnings,  which  is  at  a  premium  to  our  1-year  forward  target P/Es  for  the  construction  sector  of  10x-16x to reflect the group’s large market  capitalisation  and  high  share  liquidity.  Based  on  our  forecasts and  its  current share price, Gamuda’s P/E could  rise  to  20x  in  FY16F from  17x  in  FY15F  on  the  back  of  a  13%  contraction  in  earnings  in FY16F.  We  believe  such  rich  potential  valuations  as  a  result  of  poor earnings growth prospects over the next 12 months, could cap its share price performance.

A  valuation  call. We downgrade  Gamuda  to  NEUTRAL  from  Buy  given the limited 3% upside to our TP of MYR5.35. Despite a general weak equity market in Malaysia, Gamuda’s share price still  nudged  up  by  3%  YTD,  bringing  its  gains  since  2013  –
largely fuelled by the market’s excitement over its  involvement  in  the  Klang  Valley MRT project – to a whopping 42%. We see a declining reward-versus-risk profile for Gamuda over the next 12 months due to the following reasons:
i)  consensus estimates for Gamuda’s FY16 earnings are behind the curve – having erred on what we term as “the side of not listening”, 

ii)  the  rising  risk  of  its  property  profits  on  the  continued  deterioration  in  the confidence and sentiment of property buyers in general,

iii)  while  the  market  prices in Gamuda’s potential gains from the  MYR27bn  Penang Transport Master Plan, it may have overlooked the “pains before gains” including a potential cash call,
iv)  further delays in the disposal of Gamuda’s 40% stake in Splash, and

v)  the  possibility  of  the  Government  eventually  deferring  certain  public  jobs  on  the back of the continued slump in oil and gas prices. FY16  earnings  may  contract.  During  an  analyst  briefing  in  Dec  2014,  Gamuda’s management  guided  for  an  earnings  contraction  in  FY16,  as  Line  2  of  the  Klang Valley MRT project (MRT2) will not come in soon enough to fill up the vacuum to be left  by  Line  1  (ie  MTR1).  Gamuda  expects  public  display  and  feedback  for  the MYR25bn  MRT2  to  happen  by  1Q15,  tender  calling  by  3Q15  and  the  award  of contracts by 1Q16. Even if physical works commence immediately in 1Q16 or 2Q16, MRT2 earnings contributions to its FY16 bottomline could still be negligible, given the very initial phase of the project (that will only involve  the mobilisation of equipment). Meanwhile,  civil  works  on  Line  1  are  on  track  for  completion  by  mid-2015,  which means  it  will  not  contribute  significantly  to  numbers  in  FY16  as  well,  other  than
writebacks of over-provisions, if any.

Despite Gamuda’s explicit guidance for an earnings contraction in FY16 since three months  ago,  the  consensus  estimate  for  Gamuda’s  FY16  net  profit  remains stubbornly  bullish  –  rising  by  5%  to  MYR797m  from  the  MYR758m  projected  for FY15. We  forecast a  13% decline  in  Gamuda’s FY16 net profit, down  to  MYR609m from  the  MYR702m  we  projected  for  FY15.  We  expect  Gamuda  to  reiterate  its guidance  for  an  earnings  contraction  in  FY16  during  its  coming  quarterly  analyst briefing,  sometime  at  the  end  of  this  month.  This  would  eventually  bring  the consensus estimate on its FY16 earnings.

Downside  risk  to  property  profits.  Like  other  property  developers  in  Malaysia, Gamuda’s property business will probably  not  be  spared  the  rising  earnings  risk  on the  back  of  continued  deterioration  in  the  confidence  and  sentiment  of  property buyers  in  general.  Already,  the  latest  quarterly  results  of  property  giants  IJM  Land (IJMLD  MK,  BUY,  TP:  MYR4.22)  (Oct-Dec  2014)  missed  both  our  and  consensus estimates,  while  that  of  SP  Setia  (SPSB  MK,  BUY,  TP:  MYR4.08)  (Nov  2014-Jan 2015) met our projection but fell short of market expectations.  

Property  developers, in  general,  have  seen slower  conversion  of bookings to  actual sales,  partly  due  to  the  more  stringent  lending  policies  by  the  banks.  Not  helping either is the wait-and-see attitude of property buyers ahead of the implementation of
the  Goods  and  Services  Tax  (GST)  on  1  Apr  2015.  Most  property  developers  have scaled  down  their  new  launches.  During  its  analyst  briefing  in  Dec  2014,  Gamuda announced  it  was  putting  its  FY15  property  sales  target  of  MYR1.84bn  (vis-à-vis MYR1.81bn  achieved  in  FY14) “under review” amidst headwinds  in  the  property sector  –  particularly  in  the  Iskandar/Johor  Bahru  market.  In  FY14,  property development contributed 26% of Gamuda’s total PBT.

Potential “pains before gains” from Penang Transport Master Plan. The market (which  includes  RHB)  generally  expects  Gamuda  to  emerge  as  the  winner  in  the       6-horse  race  for  the  project  delivery  partner  (PDP)  role  in  the  MYR27bn  Penang Transport  Master  Plan  project.  The  Edge  Financial  Daily  recently  quoted  Penang traffic  management  exco  Mr  Chow  Kon  Yeow  as  saying  that  the  State  Government had  received  proposals  from  six  bidders  (without  naming  them)  for  the  PDP  role  of the master plan, including three “local public-listed construction giants”. Thus far, Gamuda and WCT have confirmed with us that they have submitted a bid while the identities  of  the  remaining  four  bidders  are  unknown.  The  state  has  appointed consultancy firm KPMG to evaluate the bids and is expected to announce the winning bid by May 2015.

To recap, the master plan is an initiative by the Penang State Government to improve the  highway  network  and  develop  an  integrated  public  transport  system  –  one  that combines  buses,  trams,  light  rail  transit  (LRT)  and  water  taxis  in  Penang Island/Seberang Prai. We believe this plan, spanning from 2014 to 2030, is realisable given the availability of “rights to reclaim land” to the Penang State Government as its core  funding  option.  The  Edge  Financial  Daily,  quoting  a “government source”, reported  that  a  50.6ha  bed  in  Middlebank,  located  between  Penang  island  and  the Sungai  Pinang  river  mouth  (see  shaded  area  in  Figure  1),  had  been  earmarked  for this purpose.

Physical works on various components of the master plan are unlikely to commence anytime  soon  after  the  announcement  of  the  winning  bid  for  the  PDP  role  of  the project. For instance, the MYR4.5bn 17.5km light rail transit (LRT) linking Komtar in the  heart  of  George  Town  to  Penang  International  Airport  (a  key  component  of  the master plan), will have to go through the same processes as in the case of the Klang Valley  MRT  project  such  as  public  display  and  feedback, confirmation  of  alignment, detailed design, various approvals from both the Federal and State Government, land acquisition and site possession. We believe even if Gamuda were to be picked as the PDP for the master plan in May 2015, earnings impact from the project would not be felt until FY18.  

Most importantly, as the master plan’s funding will be largely payment in kind in the form  of  “rights to reclaim land”, if Gamuda were to be appointed the PDP, it would probably incur massive cash outflows during the initial years, in order to fund: i) the construction  of  various  components  of  the  master  plan  (for  instance,  the  LRT  line alone  would  cost  MYR4.5bn),  and  ii)  the  land  reclamation  before  the  land  could  be monetised,  either  via  sales  of  land  or  properties  to  be  built  on  the  land  (while  one
could argue that Gamuda could sell the “rights to reclaim land” outright to generate cashflow, this would not allow it to maximise the return from the land).  

Assuming  a  70:30  debt-to-equity funding structure for the “rights to reclaim land” worth  MYR4.5bn  Gamuda  was  to  receive  for  the  construction  of  the  LRT  line,  the company  would  need  to  raise  new  equity  amounting  to  MYR1.35bn  for  this component  of  the  master  plan  alone.  While  the  proceeds  from  the  disposal  of Gamuda’s 40% stake in water producer Syarikat Pengeluar Air Sungei Selangor SB (Splash) worth about MYR1.1bn (based on book value) would have come in handy, we  believe  that  this  is  unlikely  to  happen  over  the  immediate  term  as  the  master agreement  on  water  restructuring  signed  between  the  Federal  and  Selangor  State governments  recently  lapsed.  As  such,  we  believe  that  if  Gamuda  were  to  be involved  in  the  Penang  Transport  Master  Plan  project  and  given  the  size  of  the project, the company would effectively be entering into a new “investment phase” that would  require  substantial  new  equity.  We  believe  that  a  cash  call  would  be  rather natural.

No  solution  in  sight  for  Splash.  As  mentioned,  the  master  agreement  on  water restructuring  signed  between  the  Federal  and  Selangor  State  governments  recently lapsed.  We  believe  the  impact  on  Gamuda  is  mixed.  On  one  hand,  if  the  parties involved are to renegotiate for a new deal, the terms of the new deal are unlikely to be worse for Splash – as the old deal valued Splash at only 0.1x its book value. On the  other,  it  may  take  years  for  the  parties  to  cut  a  new  deal.  Based  on  our conversations with Gamuda, we sense that there has been a change in thinking since 6-9 months ago on how Gamuda intends to use the proceeds. We believe Gamuda is more  inclined  to  put  the  money  on  standby  for  the  possibility  of  investing  it  in  the Penang  Transport  Master  Plan,  instead  of  distributing  the  money  back  to shareholders  in  the  form  of  a  special  dividend.  In  any  case,  this  has  now  become academic – as the disposal of Splash will not happen over the immediate term.

Project deferment on falling oil revenue. Despite lower oil revenue, in the revised Budget 2015 announced in Jan 2015, the Government has decided to maintain gross development  expenditure  at  MYR48.5bn,  up  15%  YoY  from  the  MYR42.2bn estimated for 2014. This sends out a strong signal to the market on the Government’s commitment towards public infrastructure spending. However, one cannot totally rule out the possibility of the Government eventually having to defer certain public jobs on the  back  of  the  continued  slump  in  oil  and  gas  prices.  This  could  potentially  be negative for the company, as the sole lifeline of its construction division comes from a single government job, ie the MYR73bn Klang Valley MRT project.

Forecasts.  We keep our forecasts relatively unchanged.

Risks  to  our  view:  i)  delays  and  cost  overruns  in  construction  jobs,  and  ii)  weak property sales.

Downgrade  to  NEUTRAL.  We  downgrade  our  call  to  NEUTRAL  from  Buy.  While Gamuda is the best proxy to the buoyant construction sector given its dominant role in  the  MYR73bn  Klang  Valley  MRT  project,  there  is  now  limited  upside  to  its  share price after it appreciated by 42% since 2013. Also, we believe while the market has priced in “gains” from Gamuda’s potential involvement in the MYR27bn Penang Transport Master Plan, it has overlooked the “pains before gains” including  the possibility of a cash call. We maintain our SOP-based TP at MYR5.35 which values Gamuda’s  construction  business  at  18x  1-year  forward  earnings  –  at  a  premium  to our 1-year forward target P/Es for the construction sector of 10x-16x – to reflect the group’s large market capitalisation and high share liquidity (see Figure 3). Based on our forecasts and the current share price, Gamuda’s P/E could rise to 20x in FY16F from  17x  in  FY15F  on  the  back  of  a  13%  contraction  in  earnings  in  FY16F.  We believe rich valuations owing to the company’s poor earnings growth prospects over the next 12 months could cap its share price performance. 

Financial Exhibits

Financial Exhibits

SWOT Analysis

Company Profile

Gamuda is primarily involved in construction, property development, toll road operations and the production of treated water.  It is the
leading  player  in  public  infrastructure  in  Malaysia  by  virtue  of  its  project  delivery  partner  and  tunnelling  contractor  roles  in  the construction of the Klang Valley MRT project.

Recommendation Chart

Source: RHB