• Maintain SELL with unchanged TP of MYR0.50, 24% downside. Results were weaker than expected as earnings were largely supported by a lower effective tax rate and unrealised FX gains. We cut our earnings estimates further to reflect lower overall project margins. Despite that, earnings could recover in 2HFY21 into FY22 following the gradual reopening of the local economy. However, at the current juncture, we think the risk-reward proposition remains unattractive as downside risks to earnings are pronounced.

• 1QFY21 (Jan) core earnings of MYR3.7m (-45% QoQ, -72% YoY) missed at 8% of our/Street expectations. Revenue halved amidst the global pandemic, with EBIT margins narrowing to 9% (-2.6ppt QoQ, -12.3ppt YoY) on higher idle cost. We note that the effective tax rate was lower at 7% and there were unrealised gains on FX of MYR3.9m (1QFY20: MYR0.3m), which we deem as part of core net profit due to its recurring nature.

• Results review. Construction revenue fell 58% YoY to MYR21.5m (-59% QoQ) on the back of muted progress for the Endocrine Hospital project (c.3% in the first four months of CY20) due to complications with approvals. Hospital Tanjung Karang fared better comparatively, progressing c.10% (c.1.3% in the months of March and April). Construction EBIT margins dipped into single-digit territory at 6.3% (5-year average: 25%).

• Playing catch-up in 2HFY21. We expect George Kent Malaysia to post recovery in earnings as Malaysia enters the recovery phase of the Movement Control Order (MCO). Utilisation for its water meter manufacturing plant is at 55%, and construction works for both hospital projects resumed in June after foreign workers were cleared of COVID-19. However, we note that part of our FY22F earnings growth is driven by contributions from the smart metering segment and Light Rail Transit (LRT) 3 JV – the absence of these would narrow FY22F earnings to MYR32m (-34% of our latest forecast).

• We cut FY21F-FY22F earnings by 14% and 5% to reflect lower overall project margins, while leaving FY23F earnings unchanged. Our ascribed FY22F target P/E is lifted to 5.7x, which is -1SD from its 5-year rolling average post earnings revision. We think this is fair given the persisting orderbook concentration risk alongside replenishment concerns, execution risk, and hazy policy imperatives. Despite that, the strong share buyback initiatives and net cash position (MYR0.31/share) may offer support to the share price, although net cash continues to diminish. The stock currently trades in line with small-cap peers at 7.2x FY22F P/E.

• Potential upsides to our call include stability in the macro economy, a positive outcome for water reforms, higher-than-expected earnings contributions from the LRT3 project, and further wins in water-related infrastructure contracts.

Source: RHB Securities Research - 24 Jun 2020