Since our last report dated 8/8/16, GKENT’s (i) share price surged 35%, (ii) 1H17 results outperformed expectations at 56% due to our conservative construction margins, (iii) GKENT with CCCC secured system works package for MRT2 worth RM1.01b and (iv) bonus issue completed with the issuance of 75.1m new shares. Post results, upgrade GKENT’s FY17 CNP by 18%. Reiterate our Trading Buy call with higher TP of RM2.80 (from RM2.17) based on SOP and selected GKENT to be our Top 10 Picks in 4QCY16.

1H17 results above expectations. 1H17 CNP of RM35.5m came in above expectations accounting for 56% of our full-year estimate. The positive variance was due to higher-than-expected margins achieved in their engineering division. 3.0 sen dividend declared, which was within our full-year estimates of 8.0 sen. 1H17 CNP was up 93.7% YoY on the back of: (i) stronger revenue (+65.7%) due to higher engineering billings (+85.5%) coupled with stronger construction margins (+2ppt), (ii) higher interest income (+30.4%), (iii) higher contribution from associates and JV (+216.6%), and (iv) lower effective tax rate (-6ppt). 2Q17 CNP was up 36.7% QoQ mainly underpinned by: (i) higher PBT contributions from metering division (+120.4%) on the back of higher metering revenue (+15.7%) with better margins (+12ppt), and (ii) higher contributions of associates/JV (+149.2%).

System works for MRT 2. On 25th of August, GKENT together with CCCC under a 49:51 JV structure managed to secure the Systems Works Package (SSP-SY-204) from MRT Corp S/B worth RM1.01b. The contract entails engineering, procurement, construction testing and commissioning of track works, maintenance vehicles and work trains for MRT 2 (SSP line) slated for completion in 1st May 2021 for Phase 1 and 1st May 2022 for other remaining works. We are mildly positive on the win as although GKENT’s 49% portion of c.RM495m is within our orderbook replenishment target of RM700m (making up 70%), we note that GKENT’s has outstanding tenders for 2 hospital jobs worth RM700m which we believe is highly achievable based on their track record within the health care sector since 2009. Nonetheless, we choose to keep our FY17 replenishment target of RM700m unchanged for now as the awards for the hospital jobs might cross over into FY18. Post–award, GKENT’s outstanding orderbook stands at c.RM1.1b (exclude LRT3 PDP role) providing healthy earnings visibility for the next 2 years.

4-for-1 bonus issue completed. GKENT’s proposed 4-for-1 bonus issue was completed on the 22nd of September 2016 with the issuance of 75.1m new shares. Outstanding GKENT shares currently stand at 375.5m.

Earnings Upgrade for FY17! Post outperformance in results, we upgrade FY17 earnings by 18% but make no changes to FY18 earnings after tweaking our conservative FY17 engineering margins higher from 12% to 15%.

Reiterate TRADING BUY and included in our Top 10 picks. Since our last report (8/8/16) GKENT has surged by 35%. After adjustment in earnings and accounting for the new bonus shares, we upgrade GKENT’s fair value higher to RM2.80 (from RM2.17) based on new SoP valuations. Within our SoP (refer back), we have upgraded our conservative construction division’s valuations higher from 10x to 12x FY17 PER in line with peers such as MITRA, GADANG and KERJAYA. We believe the upgrade is justifiable considering: (i) GKENT’s strong net cash position, and (ii) superior construction PBT margin of 18% in 1H17, which is above peers’ range of 12-17%. However, despite the stronger margin, GKENT’s outstanding order book of RM1.1b still trails behind peers’ range of RM1.6b to RM2.9b; hence, we believe the 12x FY17 PER for their construction arm is fair. That said, we believe potential re-rating catalyst for GKENT is higher construction contract value for LRT3 of above RM9.0b as this would further increase profitability based on the PDP fees of 6%. We have also selected GKENT to be a Top 10 Picks for our 4QCY16 strategy.

Source: Kenanga Research - 4 Oct 2016