Sunway Construction is an integrated contractor that provides both general and specialist contracting services. It has a strong track record in the mass rapid transit segment, which is one of the key focus areas of infrastructure spending in Malaysia. Its earnings visibility is strong underpinned by recurring jobs from its parent and key blue-chip clients. We initiate coverage with a BUY call and a TP of MYR1.40 (22% upside).

A seasoned player. Sunway Construction is one of the largest contractors in Malaysia by construction revenue. Apart from the bread and butter building and civil & infrastructure construction services, the company also provides the more specialised: i) foundation & geotechnical engineering, and ii) mechanical, electrical & plumbing (MEP) services. In addition, it runs a highly profitable precast concrete products manufacturing operation in Singapore.

Investment case. We like Sunway Construction for: i) its wide range of capabilities (both general and specialist construction services) that translates into enhanced competitiveness in the market ii) its strong track record in mass rapid transit projects, iii) its strong “internal” client, i.e. parent Sunway Bhd (SWB MK, BUY, TP: MYR3.86) that is an important source of recurring construction jobs, iv) its strong external client base comprising KLCC/Petronas, Khazanah, Putrajaya Holdings, MRT Co and Prasarana, and v) its highly profitable pre-cast operation in Singapore.

Risks to our view: i) job wins in FY15-17F falling short of our MYR2.2bn per annum assumption (YTD in FY15, it has secured MYR2bn new jobs), ii) higher-than-expected input costs and iii) weak demand for its precast concrete products in Singapore (see Key Risks on page 15).

Initiating coverage with BUY. Sunway Construction’s earnings visibility is strong, backed by: i) an existing order backlog of MYR4.3bn (MYR4.0bn in construction and MYR0.3bn in precast concrete products), and ii) recurring orders from its parent and key blue-chip clients that are engaged in massive long-term projects (such as the development of townships, mass public transport systems, a new economic zone and an administrative centre). We derive a TP of MYR1.40 for Sunway Construction by pegging it to 14x FY16F EPS, in line with our benchmark upcycle 1-year forward target P/E of 14x for mid-cap construction stocks. At the current price, Sunway Construction trades at undemanding P/Es of 12.4x for FY15F and 11.5x for FY16F

Valuation

We derive a TP of MYR1.40 for Sunway Construction by pegging it to 14x FY16F S, which is in line with our benchmark upcycle 1-year forward target P/E of 14x for mid-cap construction stocks (we ascribe target P/Es of 10-12x and 16-18x for small-cap and large-cap construction stocks respectively) At 14x FY16F earnings, our valuation for the company is: i. In line with sector weighted average of 14.1x (see Figure 1) ii. At a premium to 12.7x P/E of mid-cap peer WCT (WCTHG MK, BUY, TP: MYR1.55) which is understandable given that WCT offers less leverage to the construction sector as we project about two thirds of its earnings in FY16 to come from property development and investment iii. At a premium to 6.2-11.8x P/Es of its small-cap peers comprising Naim Holdings (NHB MK, BUY, TP: MYR3.18), Pintaras Jaya (PINT MK, BUY, TP: MYR4.60), Protasco (PRTA MK, BUY, TP: MYR2.27), Kimlun Corp (KICB MK, BUY, TP: MYR1.65), Ahmad Zaki Resources (AZR MK, BUY, TP: MYR0.98) and Hock Seng Lee (HSL MK, NEUTRAL, TP: MYR1.75) given Sunway Construction’s relatively larger size iv. At a discount to 17.0-18.4x P/Es of its large-cap peers comprising Gamuda (GAM MK, BUY, TP: MYR5.26) and IJM (IJM MK, BUY, TP: MYR3.39) given Sunway Construction’s relatively smaller size

Corporate Profile

A seasoned player in the construction in Malaysia. Sunway Construction is one of the largest contractors in Malaysia by construction revenue. Apart from the bread and butter building and civil & infrastructure construction services – which most players in the industry are able to offer – the company also provides the more specialised:

i) foundation & geotechnical engineering, and ii) MEP services. In addition, it runs a highly profitable precast concrete products manufacturing operation in Singapore, supplying largely to Housing and Development Board (HDB) projects in the island republic.

It is registered with the Construction Industry Development Board (CIDB) as a “Grade 7” construction company, the highest classification accorded by the board. This allows the company to tender for contracts of unlimited value in Malaysia. In addition, Sunway Construction’s Certificates of Procurement of Government Work – also issued by the CIDB – entitles the company to bid for government and government-related projects. In Singapore, Sunway Construction is registered with the Building & Construction Authority (BCA) as a “L6” contractor, ie one that is capable of undertaking precast concrete works of unlimited value. For FY14, building construction contributed 35% of group turnover (before consolidated adjustments), followed by civil & infrastructure (27.1%), foundation & geotechnical engineering (11.9%), precast concrete products (13.1%) and MEP (12.9%). However, in terms of gross profit contribution, precast concrete products led the pack with 27.4%, followed by civil & infrastructure (26.0%), building construction (22.8%), foundation & geotechnical engineering (13.8%) and MEP (9.7%). By geographical breakdown, 86.4% of total revenue came from Malaysia and 13.6% from Singapore, while in terms of gross profit, 76.6% originated from Malaysia, followed by Singapore (23.1%) and others (0.3%).

We believe that Sunway Construction’s diverse capability profile could be traced back to its inception in the early 1980s when the “modern” construction sector in Malaysia was still in its infancy. In the absence of a pool of proven and reliable subcontractors, over time Sunway Construction accumulated various specialised capabilities and equipment that complemented its core building and civil and infrastructure construction expertise. The company has retained this “insourcing” model until today despite the availability of “outsourcing” with the proliferation of small subcontractors in the market over the last 1-2 decades. These small subcontractors are able to offer very competitive rates given their very lean setup. Not only has Sunway Construction not scaled down or wound down its operations in foundation & geotechnical engineering and MEP, it has actually grown them to offer services to third parties apart from providing support to in-house jobs; thus Sunway Construction was able to continue reinventing itself to stay relevant and competitive in the business segments that it is engaged in. Among Sunway Construction’s maiden projects in Malaysia in the early 1980s were road resurfacing, highway rehabilitation, and drainage and sewerage works. It got its first break when it successfully completed the Langkawi Jetty project (awarded by the Ministry of Works) ahead of the 11th Commonwealth Heads of Government Meeting that were held in Langkawi in Oct 1989. It has not looked back since. Over the last three-and-a-half decades, the company has completed a long list of construction jobs worth more than MYR20bn in Malaysia, the United Arab Emirates (UAE), India and Singapore (supply of precast concrete products) (see Appendix). Among Sunway Construction’s most notable completed construction projects are the: i) Sunway Pyramid Shopping Mall & Sunway Pyramid Shopping Mall’s Phase 2 (MYR508m), ii) Kajang Traffic Dispersal Ring Road (MYR1,045m), iii) Kuala Lumpur Convention Centre (MYR549m), iv) Ministry of Housing & Local Government and Ministry of Women, Family & Community Development buildings in Putrajaya (MYR520m), v) Legoland Malaysia Theme Park (Package 4) (MYR258m), and vi) Pinewood Iskandar Malaysia Studios (MYR309m).

Sunway Construction was incorporated under the name of Sungei Way Quarry SB in 1976. This was changed to Sungei Way Quarry & Construction SB in 1981 and, subsequently Sungei Way Construction SB in 1984. In 1997, the entity was converted into a public limited company and listed on the Main Board of the Kuala Lumpur Stock Exchange (now known as the Main Market of Bursa Malaysia) under the name of Sungei Way Construction. This was changed to Sunway Construction two years later

In 2003, parent Sunway Holdings Incorporated took Sunway Construction private by acquiring the remaining 72m shares, or a 39% stake, in the company that it did not own for MYR2.73 per share. This was satisfied by MYR1.10 cash and one new Sunway Holdings Incorporated share at an issue price of MYR1.63. The deal effectively valued Sunway Construction in its entirety at MYR505m. Sunway Construction became a wholly-owned subsidiary of Sunway Holdings Incorporated and was delisted in 2004.

After the privatisation, Sunway Construction has grown its revenue by almost twofold to MYR1.9bn in FY14 from MYR1.08bn in FY03. It has also more than doubled its net profit to MYR114m from MYR51.1m during the same interval. In terms of order backlog, this has more than quadrupled to MYR4.3bn as at end-2Q15 – comprising MYR4.0bn outstanding construction orderbook (see Figure 2) and a MYR306m balance order from precast concrete products – from MYR1bn in early-FY04. At the Malaysian Construction Industry Excellence Awards (MCIEA) 2013 – hosted by CIDB in September last year – Sunway Construction walked away with the Builder of the Year Award. Meanwhile, founder and chairman – Tan Sri Dr Jeffrey Cheah – received the Prominent Player Award and managing director Mr Kwan Foh Kwai bagged the CEO of the Year Award. Sunway Construction had been no stranger to MCIEA’s Builder of the Year Awards, having won this accolade in 2003 and 2005.

Key Investment Themes

Integrated operations, enhanced competitiveness Given its wide range of capabilities comprising building construction, civil & infrastructure, foundation & geotechnical engineering and MEP, Sunway Construction is well-positioned to fully capitalise on business opportunities prevailing in various segments within the construction sector in Malaysia. It has strong presence in both: i) the “volume game” – which is the highly competitive building construction and civil & infrastructure space, and ii) the “margin game”, ie the less crowded specialised foundation & geotechnical engineering and MEP segments.

Typically, foundation & geotechnical engineering and MEP constitute specialist works within a turnkey building construction or civil & infrastructure contract. As such, we have strong reasons to believe that Sunway Construction is also able to leverage on these in-house specialist capabilities to boost its overall competitiveness when bidding for turnkey building construction and civil & infrastructure jobs. First, we believe the specialist works provided by Sunway Construction are at least on par with those provided by third-parties in terms of cost and quality, as evidenced by the ability of the company’s foundation & geotechnical engineering and MEP units to secure external contracts on a competitive basis. Second, the “insourcing” of two major specialist work components of a contract allows it to achieve better design optimisation, interfacing of works, and control over work quality and timeliness of completion. All these would translate to synergy, efficiency and cost savings, and hence Sunway Construction’s sharpened competitiveness in the market. The key risk to its integrated operations is the ownership costs associated with each specialist segment, such as depreciation of equipment and staff costs. Sunway Construction will have to carry these costs during a sector downturn when there are fewer jobs available in the market. The problem does not arise for a contractor which relies on specialist services from third parties.

A good proxy to mass rapid transit developments in Malaysia One of the key pillars of support for the construction sector in Malaysia over the next decade and beyond is spending in mass rapid transit developments, particularly in the Klang Valley and Penang. A rail-based mass transit network will eventually take over the existing land-based road network as the backbone to the public transportation system in densely populated areas like the Klang Valley and Penang, as Malaysia marches towards a developed nation status. Industry players are set for an exciting time ahead with the almost concurrent implementation of mass rapid transit (MRT) 2, light rail transit (LRT) 3, Penang Transportation Master Plan and more bus rapid transit (BRT) projects (see Figure 4).

We believe that Sunway Construction is well-positioned to capitalise on the various mass rapid developments in Malaysia, which are detailed below: i. It is poised to bag at least a viaduct package from MRT2, given its strong track record in carrying out Package V4 of MRT1 (contract sum of MYR1,173m, 63%-completed as at end-June 2015), and the experience and a fleet of equipment it built up from executing the job ii. Similarly, it is a strong contender for a main facilities package of LRT3, given its involvement in a main facilities package of LRT3 (contract sum of MYR569m, 86% completed as at end-June 2015) iii. Sunway Construction is more than qualified to bid for work packages from a key component of the Penang Transport Master Plan, ie the MYR4.5bn 17.5km LRT line connecting Komtar in the heart of George Town to the Penang International Airport, backed by its rail development track records in MRT1 and LRT2

iv. It has a first-mover advantages over its peers in the industry in the elevated BRT space, given its involvement in the 5.4km BRT Sunway Line, which is the first transit system based on elevated and dedicated bus lanes in Malaysia (see Figures 5 & 6 for the alignment and an image of the BRT Sunway Line). In its Land Public Transport Master Plan published in Jun 2013, SPAD identifies 12 “BRT corridors” (including the BRT Sunway Line) for development (see Figure 7)

Recurring construction jobs from parent Sunway Construction can rely on parent Sunway, one of the largest and most prominent property developers in Malaysia, for recurring construction jobs. As at end-June 2015, its outstanding “in-house” construction orderbook comprising construction works from, among others, Sunway Velocity Mall, Sunway University, Sunway Putra Place, Sunway Pyramid and Sunway Medical Centre, added up to MYR1,059m. This was equivalent to about 25% of Sunway Construction’s total outstanding construction orderbook of MYR4.3bn. We believe the company can continue to count on parent Sunway for new jobs, given the latter’s massive outstanding GDV of MYR54.6bn from its landbank totalling 3,407 acres (see Figure 8).

Source: RHB Research - 18 Sep 2015