• Upgrade to BUY from Neutral with new MYR0.92 TP (DCF) from MYR0.89, 31% upside. UEM Edgenta’s core earnings rose 41% QoQ to MYR12.5m, bringing its 1H24 numbers to MYR21.4m – accounting for 58% of our FY24 estimate. Results were above expectation, aided by ongoing contracts recognition from Singapore and Taiwan (healthcare division) and higher work order from the infrastructure segment. We upgrade the stock to BUY as the infrastructure segment should see a seasonally stronger 2H24. UEME is currently trading at 2SD below its historical mean of 17x.

• Results overview. UEME’s 2Q24 core earnings leaped 41% QoQ to MYR12.5m (1Q24: MYR8.9m), thanks to higher revenue recognition from Infrastructure Services (IS) division (likely driven by higher work order on the back of higher number of working days in 2Q), recognition from ongoing commercial contract from healthcare service (HS) division in Singapore and Taiwan, as well as contribution from Property and Facility Solution (PFS) division from the consolidation of newly acquired entities MEEM and Kaizen Group (both are 60% owned). To-date, the group has secured MYR2bn worth of new contracts in 1H24 (1H23: MYR922m, 2023: MYR2bn), bringing its total outstanding orderbook to MYR10bn. Based on our estimates, this is expected to provide UEME with earnings visibility of three years.

• Margin and outlook. 2Q24 core margin expanded slightly by 0.3ppt QoQ to 1.7%, mainly driven by better operating efficiency from IS division and offset against the heightened cost pressure from HS division. Moving forward, we expect margin compression risk to persist in view of a relatively sticky cost nature, primarily labour cost. Nonetheless, we expect UEME to post a stronger 2H24 as the IS division should see higher work order as clients will typically utilise their remaining budget towards 4Q.

• Earnings estimate and valuation. We raised our 2024-26 earnings by 8%, 8%, and 8% as we tweak our revenue assumption for IS division to factor a higher work order. We maintain our full-year net margin assumption of 1.3% as we believe the persisting cost pressure will weigh on UEME’s profitability. Our DCF-derived TP is higher at MYR0.92, implying -0.4SD below its pre- COVID-19 historical mean. Despite earnings picking up sequentially, we remain cautious on the potential cost pressure from the rationalisation of the diesel subsidy programme, which could erode profitability. In the meantime, cost pass-through appears challenging (the bulk of its orderbook (c.70-80%) are concession-based, with the rest being commercial), and we do not expect profitability to recover to pre-pandemic levels (c.6-7%). Our TP incorporates an 8% ESG premium as UEME’s ESG score is above the country median.

• Key risks: Termination of contracts, higher-than-expected operating costs, and cutback in infrastructure spending.

Source: RHB Research - 30 Aug 2024