• Stay NEUTRAL and MYR1.00 TP, 10% downside. Earnings for the construction segment could pick up gradually, as LRT3 project should resume in 2H19. George Kent could benefit from the implementation of water projects and smart meters, although the outcome of Malaysia’s water restructuring initiative remains unclear. A positive outcome for water reform – paving the way to higher development allocation for the sector – could be a rerating catalyst.

• 1QFY20 (Jan) net profit declined 37% YoY to MYR13.5m, in line with our and consensus estimates, representing 19-22% of FY20F – we expect 2HFY20 to be better. Construction PBT fell 53% QoQ and 23% YoY, due to lower construction billings and JV losses amounting to MYR0.6m (from a gain of MYR9.2m in 1QFY19), as progress on the Light Rail Transit 3 (LRT3) project remains subdued. Construction PBT margins expanded 3ppts to 32% in 1QFY20, likely due to favourable project billings.

• LRT3 likely to resume in 2H19. Negotiations are underway and construction is anticipated to resume in the latter part of 2019. George Kent maintains an outstanding construction orderbook of MYR5bn, with a large portion comprising the LRT3 turnkey project.

• Potential beneficiary of water related projects. A positive conclusion to Malaysia’s water restructuring exercise could lead to an increase in development expenditure for water projects, eg water treatment plants (WTPs), reservoirs, raw water transfer projects, and water pumping stations. This may present contracting opportunities for the company as a vertically integrated service provider – given its expertise in M&E, civil engineering and water metering & valve manufacturing. We believe this will be a rerating catalyst for the stock.

Meanwhile, George Kent is eyeing water meter replacement jobs, and smart meter orders under non-revenue water (NRW) reduction schemes.

• Key assumptions and risks. Our target P/E of 9x is at -1SD from its 10- year average 1-year forward P/E of 12x. We expect George Kent to secure MYR300m worth of new contracts during FY20F-22F, particularly for the construction of WTPs. Risks to our call include cost overruns on the LRT3 project, a prolonged slowdown in construction activities, and low win-rate in the open tender system.

Source: RHB Securities Research - 26 Jun 2019