Investment Highlights

• We cut our FY20–21F net profit forecasts by 20% and 34% respectively, but raise our FV by 18% to RM2.64 (from RM2.23) as we change our valuation method to sum-ofparts (SOP) (from straight P/E) to better reflect the monetisation of Gamuda’s water and toll road assets. Our valuation basis for Gamuda’s construction business (within the SOP valuation) remains unchanged at 10x forward earnings, in line with our benchmark forward target P/E of 10x for large-cap construction stocks. Maintain UNDERWEIGHT.

• Having made known its intention to acquire all of Gamuda’s toll road assets in February 2019, i.e. Lebuhraya Damansara Puchong (LDP), Sistem Penyuraian Trafik KL Barat (Sprint), Lebuhraya Shah Alam (Kesas) and Smart Tunnel (Smart), the government has finally come out with its offer prices for them.

• To recap, Gamuda’s stakes in the toll road assets are as follows: 1. An effective 43.6% stake in LDP via its 43.6% stake in Lingkaran Trans Kota Holidngs Bhd (Litrak) (LDP is wholly-owned by Litrak); 2. An effective stake of 51.8% in Sprint by virtue of: (a) a 30% direct stake; and (b) a 21.8% indirect stake via Litrak which owns a 50% stake in Sprint; 3. A 70% direct stake in Kesas; and 4. A 50% direct stake in Smart.

• In terms of equity value (i.e. net of debts) in their entirety, the offer values LDP, Kesas, Sprint and Smart at RM2.34bil, RM1.23bil, RM870mil and RM60mil respectively.

• As compared with our DCF-based valuations, we believe Gamuda is getting a good deal for LDP, Kesas and Smart, but less so for Sprint. All in at RM2.36bil, the price tag is at a 3% premium to our valuation of RM2.3bil based on a discount rate of 6% (Exhibit 1).

• We believe Gamuda is highly likely to accept the offer. We take comfort that the government has adhered to the principle of the sanctity of contract in the deal (vs. the narrative of “hardline” stance such as invoking appropriation clauses in the past). We believe this marketfrienldly approach will go towards reducing the policy risk, and hence the market risk premium as a whole.

• The RM2.36bil proceeds from the disposal would reduce Gamuda’s net debt and gearing of RM3.4bil and 0.44x (adjusted for RM1.02bil proceeds from the recently concluded disposal of its 40% stake in Splash) to RM1.1bil and 0.14x respectively.

• We cut our FY20–21F net profit forecasts by 20% and 34% respectively as we expect contributions from the toll road assets to halve in FY20F and completely be removed in FY21F, partially mitigated by interest savings from the disposal proceeds. Realistically, it will take Gamuda some time to identify new businesses to fill the vacuum. The market has high expectations on the massive Penang Transport Master Plan (PTMP) of which Gamuda is in the driver seat via its 60% stake in the consortium that has been appointed the project delivery partner.

• While the PTMP project appears viable, i.e. the three man-made islands under the Penang South Reclamation could be sold for RM70bil, more than enough to fund RM46bil reclamation cost and public infrastructure spending under the PTMP project, its implementation will be very challenging from a cash flow standpoint (apart from the political will of the state government on the back of the strong objection from environmentalists). The PTMP project will incur tremendous upfront cash flow to fund reclamation and the construction of public infrastructure, only to be recouped many years down the road via land sales from the three man-made islands. We believe this could only be possible with substantial soft loans either from the federal government or international development banks.

• We acknowledge that the revival of the East Coast Rail Link (ECRL) and Bandar Malaysia projects shall result in more jobs available in the market for local construction players. However, we believe the market has not priced in enough risk premium to reflect: 1. The fact that the latest mega projects are driven by world-class Chinese contractors (and Chinese funding) which probably leaves the local contractors with only low-value/low-margin supporting roles in the projects; and 2. The fact that given the still elevated national debt, the government has no choice but to remain steadfastly committed to fiscal prudence which means the revival of the ECRL project could be a “zero-sum game” as it impedes the government’s ability to implement other public infrastructure projects.

• We believe valuations of construction stocks, Gamuda included, have run ahead of their fundamentals in the heat of this euphoria.

Source: AmInvest Research - 24 Jun 2019