Gamuda’s 9MFY15 (Jul) results met our expectations but missed consensus estimates. We maintain our NEUTRAL call and earnings forecasts, but trim our TP by 2% to MYR5.26 (5% upside). Gamuda is the best proxy to the construction sector, given its dominant role in the Klang Valley mass rapid transit (MRT) project. However, upside to its share price may be capped given a 13% decline in earnings in FY16.

Missed consensus. Gamuda’s 9MFY15 net profit met our expectations but missed consensus estimates.

MRT2 roll-out by mid-2016. Gamuda reiterated its guidance for tender calling for the MYR28bn MRT2 project by 4Q2015 and award of contracts by mid-2016.

55% and 68% completion for MRT1. Gamuda made good progress on MRT1. As at end-3QFY15, financial completion of the elevated portion stood at 55% (vis-à-vis 50% three months ago), with the MYR8.3bn tunneling portion at 68% (vis-à-vis 61% three months ago).

FY15 property sales target maintained at MYR1.2bn. Gamuda is on track to achieve its FY15 property sales target of MYR1.2b. It managed to record sales worth a total of MYR810m in 9MFY15.

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, and iv) further delays in the disposal of its water asset. We trim our SOP-based TP by 2% to MYR5.26 (from MYR5.35) as we roll forward our valuation base year to CY16 from CY15. We value its construction business at an unchanged 18x 1-year forward earnings. 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. Its rich valuations but poor earnings growth prospects over the next 12 months could cap its share price performance. Nonetheless, Gamuda remains the best proxy to the construction sector, given its dominant role in the Klang Valley MRT project.

Missed consensus. Gamuda’s 9MFY15 net profit met our expectations at 75% of our full-year forecast but missed market expectations at only 71% of the full-year consensus estimates.

MRT2 roll-out by mid-2016. Gamuda reiterated its guidance for tender calling for the MYR28bn MRT2 project by 4Q2015 and award of contracts by mid-2016. To recap, the Government in Oct 2014 already formally appointed a 50:50 joint venture between MMC Corp (MMC MK, NR) and Gamuda (MMC-Gamuda JV) as the project delivery partner (PDP) for the elevated portion worth MYR16bn of the MRT2 project. While the terms and conditions are still pending signing, 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 MYR12bn underground portion of MRT2, as per MRT1, it will be awarded on a Swiss challenge basis, ie. via an international tender with the sole local bidder – MMC-Gamuda JV – being given “the first right of refusal at the lowest bid plus a 2.5% to 7.5% margin”. 55% and 68% completion for MRT1. Gamuda made good progress on MRT1. As at end-3QFY15, financial completion (ie. works certified done and billed) of the elevated portion (on which MMC-Gamuda JV earns a PDP fee amounting to 6% of the value of the elevated portion contract estimated at MYR14bn) stood at 55% (vis-à-vis 50% three months ago), with the MYR8.3bn tunneling portion (on which MMC-Gamuda JV earns a construction margin, we assume at 12%) at 68% (vis-à-vis 61% three months ago).

FY15 property sales target maintained at MYR1.2bn. Gamuda is on track to achieve its FY15 property sales target of MYR1.2b (which was reduced from MYR1.84bn three months ago amidst headwinds in the property sector on the back of various cooling measures introduced by the Government). It managed to record sales worth a total of MYR810m in 9MFY15 (two thirds from Malaysia and a third from Vietnam respectively based on our estimates). In FY14, Gamuda achieved MYR1.81bn property sales. As at end-3QFY15, its unbilled sales stood at MYR1.3bn, down from MYR1.5bn three months ago.

Meanwhile, Gamuda revealed that it had recently acquired a piece of leasehold land measuring 18 acres in Bukit Bantayan, about 7km east of Kota Kinabalu, Sabah, for MYR100m. It plans to develop 1,500 units of apartments on the land with a total GDV of MYR710m over eight years. It hopes to launch the project as soon as 2016. Also, Gamuda, via a 50%-owned consortium, has emerged the highest bidder among 14 for a 99-year leasehold plot of land measuring three acres in Toa Payoh, Singapore, at SGD345.9m (MYR968.5m) or SGD755 (MYR2,114) per sq ft. Upon the formal award by the Housing & Development Board (HDB), Gamuda will embark on the development of 590 units HDB flats on the land with a total GDV of SGD651m (MYR1.8bn). Recall, three months ago, Gamuda also revealed that it had acquired a piece of freehold mixed-use 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.

Gamuda’s key rationale for diversification to smallish standalone property projects in Australia and Singapore is to help cushion the decline in property earnings from Malaysia. These overseas projects typically have a shorter turnaround time given the promptness of the local authorities in granting various approvals. Gamuda also believes the property markets in these two developed economies are likely to emerge from a down cycle ahead of Malaysia, as they slipped into a slowdown much earlier than Malaysia in recent years.

Potential “pain before gain” from Penang Transport Master Plan? Gamuda is awaiting the outcome of its bid for in the PDP role in the MYR27bn Penang Transport Master Plan project, which it expects “not more than three months from now”. According to a recent report by The Edge Malaysia, only two companies are still left in the running for the job, namely, Gamuda and “a Chinese entity linked to China Exim Bank”, with Gamuda being the front runner. 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 cashflow, this would not allow it to maximise the return from the land).

Figure 1: Location of “Middlebank” in Penang

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 Pengeluaran Air Sungai 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.

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 MYR80bn 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, and iv) further delays in the disposal of its 40% stake in Splash. We trim our SOP-based TP by 2% to MYR5.26 (from MYR5.35) as we roll forward our valuation base year to CY16 from CY15. We value Gamuda’s construction business at an unchanged 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, operations of toll roads and 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 Research - 24 Jun 2015