Gamuda’s 1HFY15 results met expectations. We maintain our NEUTRALcall, earnings forecasts  and TP of MYR5.35 (3% upside). Gamuda is the best  proxy  to  the  construction  sector,  given  its  dominant  role  in  the Klang Valley MRT project, comprising MRT1, MRT2 and MRT3. However, upside to its share price may be capped as we expect FY16 earnings todecline by 13% on completion of MRT1 in FY15.

Decent 1HFY15.  Gamuda’s 1HFY15 (Jul)  net profit met expectations at 52%/48% of our full-year forecast and market estimates respectively.   

Slight  delay  in  MRT2  rollout.  Gamuda  said  that  there  is  now  a  3-6months deay in the rollout of the MYR25bn MRT2 project. This is due to the diversion of the southern corridor alignment to Bandar Malaysia from the Pandan area previously. Gamuda now guided for public display and feedback  for the  project  by mid-2015  (from  1Q2015), tender  calling  by 4Q2015  (from  3Q2015)  and  award  of  contracts  by  mid-2016  (from 1Q2016).  

FY15 property sales target cut  by a third.  Gamuda has cut its FY15 property  sales  target  by  a  third  to  MYR1.2bn  from  MYR1.84bn  amidst headwinds  in  the  property  sector,  particularly  in  the  Iskandar/Johor Bahru market,  on  the  back  of  various  cooling measures  introduced  by the Government.

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

Maintain  NEUTRAL.  We  see  a  declining  reward-versus-risk  profile  for Gamuda over the next 12 months due to: i) a 13% earnings contraction in FY16 on completion  of MRT1, ii)  the rising risk of its property profits, iii) a potential cash call to fund the MYR27bn Penang Transport Master Plan, iv) further delays in the disposal of its  water asset, and v) the  riskof the Government  eventually deferring certain public  jobs.  We maintain our  SOP-based  TP  at  MYR5.35,  which  values  Gamuda’s  construction business at 18x 1-year forward earnings. Based on our forecasts and the current share price, Gamuda’s P/E could rise to 21x in FY16F from 18x in  FY15F  on the  back  of  a  13%  contraction in  earnings in FY16F. We believe  rich  valuations  and  lower  earnings  growth  prospects  over  the next 12 months could cap its share price performance.

Slight Delay In MRT2 Rollout

Decent  1HFY15.  Gamuda’s 1HFY15 net profit met expectations at  52%/48% of our full-year forecast and market estimates respectively.

Slight delay in MRT2 rollout. Gamuda  said that there is now a 3-6 months  delay in the rollout of the MYR25bn MRT2 project. This is due to the diversion of the southern corridor  alignment to  Bandar  Malaysia (redevelopment  of the  Sg  Besi  airport) from the Pandan area previously. Gamuda now guided for  public display  and feedback  for the project by mid-2015 (from 1Q2015), tender calling by 4Q2015 (from 3Q2015) and award of contracts by  mid-2016 (from 1Q2016). Based on the revised schedule, there will now be a 12-month gap between MRT1 and MRT2. Civil works on  MRT1 are on track for completion by mid-2015.

To  recap,  the  Government  in  Oct  2014  formally  appointed  a  50:50  joint  venturebetween  MMC  Corp  (MMC  MK, NR)  and  Gamuda  –  MMC-Gamuda  JV  –  as  the project delivery partner (PDP)  for the elevated portion worth MYR15bn of   the  MRT2 project.  While  the  terms  and  conditions  are  still  pending  signing  by  mid-2015,  we believe the key ones are unlikely to significantly deviate from those of MRT1, namely, “on  time  delivery  and  within  budget”,  in  exchange  for  a  6%  PDP  fee.  For  the MYR10bn underground portion of  MRT2, as per  MRT1, we believe it is likely to be awarded on a Swiss challenge basis, ie  via an international tender with the sole local bidder – MMC-Gamuda JV – being given the right to match the lowest/winning bid.  50%/61%  completion  for  MRT1’s  elevated/tunnelling  portion.  Gamuda  made good progress on  MRT1. As at end-2QFY15, financial completion (ie  works certified done  and  billed)  of  the  elevated  portion  (MMC-Gamuda  JV  earns  a  PDP  fee amounting to 6% of the value of the elevated portion contract estimated at MYR14bn) stood at 50% (vis-à-vis 42% three months ago), with the MYR8.3bn tunnelling portion (for  which  MMC-Gamuda  JV  earns  a  construction  margin,  we  assume  at  12%)  at 61% (vis-à-vis 58% three months ago). At present,  nine  out of  the  10  tunnel boring machines deployed for MRT1 have been “decommissioned” as they have completed their portions of the tunnelling jobs.  In fact, Gamuda expects tunnelling works to be fully completed within three weeks from now.

FY15 property sales target cut by a third. Gamuda has cut its FY15 property sales target  by  a  third  to  MYR1.2bn  from  MYR1.84bn  amidst  headwinds  in  the  property sector, particularly in the Iskandar/Johor Bahru market, on the back of various cooling measures introduced  by the  Government. It  only managed to record sales  worth  a total  of  MYR535m  in  1HFY15  (two-thirds  from  Malaysia  and  a  third  from  Vietnam based on our estimates). In FY14, Gamuda achieved MYR1.81bn property sales. As at end-2QFY15, its unbilled sales stood at MYR1.5bn, unchanged from three months ago.  We  are  keeping  our  property  profit  forecasts  that  have  all  along  been  more conservative than Gamuda’s guidance.

Meanwhile, Gamuda revealed that it had recently acquired a piece of freehold mixeduse development land measuring 0.35 acre at Chapel Street in South Yarra, about 4km  from  Melbourne  central  business  district  (CBD),  for  AUD40m  (MYR115m).  It plans to develop 150 units of apartments on the land with a total GDV of MYR390m. It hopes to launch the project as soon as late  2015. We are mildly positive on the geographical  diversification  of  Gamuda’s  property  business  to  Australia  as  it  mayhelp to partially cushion the earnings trough of its property business in Malaysia over the medium term.

Potential  “pain  before  gain”  from  Penang  Transport  Master  Plan?  Gamuda  is awaiting the outcome of its bid  for  the  PDP  role  in  the MYR27bn Penang Transport Master Plan project. The market (which includes RHB)  generally expects Gamuda to emerge  as  the  winner  in  this  “6-horse  race”  –  WCT  (WCTHG  MK,  BUY,  TP:MYR1.75) has confirmed with us that it has submitted a bid while the identities of the remaining  four bidders are unknown.  The  Penang  state  government  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. 

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,  we  believe  that  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 cash flow, this would not allow it to maximise the return from the land).

Source: The Edge Financial Daily

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 Sungai Selangor SB (Splash) worth about MYR1.1bn (assuming based on book value which is acceptable to Gamuda) would have come in handy, we believe 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 giventhe  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.

Forecasts.  We maintain our earnings forecasts.

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

Maintain  NEUTRAL.  While  Gamuda is  the  best  proxy  to  the  buoyant  construction sector given its dominant role in the MYR73bn Klang Valley MRT project,  we see a declining reward-versus-risk profile for Gamuda over the next 12 months due to: i) a 13%  earnings  contraction  in  FY16  on  completion  of  MRT1,  ii)  the  rising  risk  of  its property  profits  on  continued  deterioration  in  the  confidence  and  sentiment  of property  buyers  in  general,  iii)  a  potential  cash  call  to  fund  the  MYR27bn  Penang Transport Master Plan, iv)  further delays in the disposal of  its  40% stake in Splash, and v) the risk of the Government eventually deferring certain public jobs on the back of  the  continued  slump  in  oil  and  gas  prices.  We  maintain  our  SOP-based  TP  atMYR5.35  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 10-16x  –  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 21x in FY16F from 18x in FY15F on the  back of a 13% contraction in earnings  in  FY16F.  We  believe  rich  valuations  owing  to  the  company’s  lower earnings  growth  prospects  over  the  next  12  months  could  cap  its  share  price performance.