• Downgrade to SELL, with a new MYR0.84 TP from MYR1.04, 16% downside and c.4% yield. UEM Edgenta’s 4Q23 earnings were disappointing, with a 83% YoY decline in core earnings to bring its 2023 numbers to 57%/61% of ours and Street’s expectations. PBT margins across each business segment were lower owing to the impact of cost inflation. We downgrade the stock, as it is currently trading at 0.3SD above its 5-year historical mean, on the back of a lack of near- term re-rating catalysts and cost pressure.

• Results overview. UEME delivered FY23 core earnings of MYR32m, which accounted for 57% of ours and 61% of consensus’ full-year estimates. In 4Q23, revenue from Healthcare Support (HS) division was flattish YoY whereas Property and Facility Solutions (PFS) spiked 21% YoY, likely on the back of winning a healthy contract recognition in the previous quarter. Infrastructure Solution (IS) division’s revenue grew 34% YoY and 15% QoQ, thanks to higher pavement works for the expressway as well as a seasonally stronger quarter. The group secured MYR2bn worth of new contracts in 2023 (2022: MYR1.36bn). Its outstanding orderbook currently stands at MYR9.3bn, which could provide earnings visibility of 3.2 years based on our estimate.

• Margin and outlook. 4Q23 core margin contracted 2.8ppt YoY to 0.5% as a result of heightened cost pressure, ie higher staff costs and spike in raw material prices (ie chemical products for cleaning and bitumen for road maintenance). UEME also incurred an estimated MYR3-4m repair and maintenance cost under the PFS division. Moving forward, we expect persisting margin compression, in view of the increased market competition in the PFS division and cost inflationary pressure (primarily labour). The implementation of the progressive wage model could present further downside risk.

• Post results, we cut FY24F-25F earnings by 52-58% to account for persisting cost pressure. We also lower our dividend payout assumption to 55% from 60% following a lower dividend declared in 2023 (2 sen vs 2022: 4 sen).

• Valuation. We downgrade to SELL with a lower DCF-derived TP of MYR0.84. Our new TP implies -0.3SD below its 5-year mean, as we think there could still be downside risks to margin compression arising from persisting inflation (predominantly labour and material costs). Cost pass-through appears challenging (given the bulk of its orderbook is concession-based (c.70-80%, while the rest are commercial orderbook), and we do not expect its profitability to recover to pre-COVID-19 levels (c.6-7%). Our TP incorporates 8% ESG premium as UEME’s ESG score is above the country median. Key risks include cutbacks in infrastructure activities, margins compression, and loss of recurring income from non-renewal of facility management contracts.

Source: RHB Research - 29 Feb 2024