• Maintain BUY and MYR1.93 TP, 29% upside with c.4% yield. ENGIE- SUNWAY DCS – the JV company between Sunway SK (an indirectly wholly owned subsidiary of Sunway Construction and ENGIE affiliate ECM Cooling) – has entered into a build, own, operate, and transfer agreement with Sunway South Quay (SSQ). The agreement involves building a district cooling system (DCS) and supplying cooling energy to SSQ’s development, known as Sunway South Quay Commercial Precinct 2, for 25 years – after which the DCS is transferred to SSQ.

• Based on salient terms of the JV company, Sunway Engineering (an indirect wholly owned subsidiary of SCGB), shall perform the engineering, procurement, and construction (EPC) scope of works in regard to the DCS. This should take place provided that chilled water tariffs proposed by the JV company are accepted by the client (SSQ). ECM Cooling’s affiliate shall be given the first right of refusal to perform the operations & maintenance or O&M scope of services for the said DCS project.

• What is in it for SCGB? According to the terms above, Sunway Engineering shall perform EPC works for the DCS. The contract value could be MYR35-40m with an expected net margin of 5-8% and SCGB could recognise a net profit of c.MYR1.8m, assuming a 5% net margin over three years (or MYR0.6m pa) for the completion of the DCS. Meanwhile, the agreement to operate the DCS by the JV company will entail SSQ paying monthly charges based on cooling consumption and subscribed cooling capacity in refrigerator ton. Management guided that annual profits from the DCS operation, attributable to Sunway SK’s 40% portion, are minimal over the operating period of <0.5% of FY22F profits. We believe this is a good start for SCGB to leverage on ECM Cooling’s expertise sustainable green cooling systems that could pave ways for SCGB to accelerate DCS technology adoption in future projects.

• Earnings and valuation. Due to the expected minimal net profit from constructing the DCS, combined with the probability of DCS to generate income only after two years of operation, we make no changes to our earnings estimates. We believe our unchanged valuation target P/E of 15.5x pegged to our FY23F EPS is fair and reflects SCGB’s high likelihood of securing Mass Rapid Transit 3 jobs combined with steady internal jobs. The target P/E is above KLCON’s index forward P/E of c.12.5x – considering SCGB’s commendable order book/revenue cover of c.2.8x – backed by a manageable net debt-to-equity ratio 0.17x as of end 1Q22. Our TP of MYR1.93 remains unchanged after imputing a 4% premium to our intrinsic valuation based on our proprietary ESG scoring methodology. SCGB is trading at -0.5SD from its 5-year mean P/E.
• Key risks: Possible cost overruns and higher material costs.

Source: RHB Research - 21 Jul 2022