SUNWAY is laying the groundwork for potential M&A opportunities with a strengthened balance sheet post the ICPS rights issue exercise. Meanwhile, the ICPS offer shareholders an avenue to participate in the Group’s long term growth story while simultaneously be rewarded with dividend incomes. We have tweaked our TP from RM1.63 previously (based on PBV of 0.95x) to RM1.68 (as we switch back to SoP valuation methodology following the market recovery from the meltdown in March). The recent share price weakness presents a chance to accumulate SUNWAY. Upgrade from MARKET PERFORM to OUTPERFORM.

Building up the war chest. The proposed rights issue of ICPS (Irredeemable Convertible Preference Shares) is expected to raise between RM980.3m (minimum scenario) to RM1.11b (maximum scenario). The bulk of the proceeds (RM600m-RM733m) will be used to pare down borrowings, which would trim net gearing from 0.43x (as of end-Mar) to 0.34x-0.32x on a proforma basis. SUNWAY could subsequently gear up to pursue potential M&A opportunities such as in quarry and property development businesses with additional debt headroom of ~RM1.7b-RM1.9b based on a net gearing limit of 0.5x. (More details on the ICPS terms are available overleaf).

ICPS insights. The ICPS – which come with a cumulative preferential dividend rate of 5.25% p.a. to be paid at the discretion of the company – will appeal to income-seeking investors amid the prevailing low deposit rates environment. While any declaration of preferential dividends will be at the board’s discretions, given the Group’s diversified earnings base, we reckon SUNWAY is in a position to pay dividends to the ICPS holders, with a maximum payout of RM58.4m (5.25% X1.11b ICPS) accounting for only 9% of FY21E pre-distribution net profit. At the same time, it will still be able to maintain its minimum dividend payout policy of 20% of core net profit to the ordinary shareholders. There is also a chance for the ICPS holders to be rewarded with potential capital appreciations from the offer price of RM1.00 should the ICPS (which will be listed on Bursa) trade at conversion premium (i.e. the difference between the value of the ICPS and the value of the ordinary shares if the ICPS are converted). For a quick comparison, industry peer SP Setia’s variant of preference shares, namely RCPS-iA and RCPS-iB, are currently fetching huge conversion premiums of 208% and 245%, respectively, to the ordinary shares.

Earnings outlook. Taking a view that the worst of Covid-19 is behind us with a gradual recovery likely from 2HCY20 onwards, the FY20 internal targets for property sales at RM1.4b (effective) and new construction contract wins of RM2.0b are kept intact. In addition, forward earnings visibility will be underpinned by unbilled property sales of RM2.6b and outstanding construction order-book of RM5.4b as of end-March 2020. Post our conference call with management, we have adjusted our FY20E and FY21E net profit to RM421m (+33%) and RM603m (-10%), respectively, mainly to factor in: (a) the timing of property billings including the lumpy recognition of property projects in China and Singapore upon physical completion in 2HFY20, and (b) the payment of ICPS preferential dividends next year.

Upgrade to OUTPERFORM. We have revised the TP to RM1.68 as we switch back to SoP valuation methodology (see table overleaf) amid the more stable stock market environment. (Our previous TP of RM1.63 was based on PBV multiple of 0.95x or at its historical mean). The recent share price weakness (down 6.6% since its 1QFY20 results release on 28 May) presents an accumulation opportunity. We upgrade our stock call from MP to OP. We continue to like SUNWAY for the Group’s diversified earnings base, with the resiliency of its REIT and healthcare businesses providing stability to counter the cyclical nature of the property development and construction segments over the longer term

Source: Kenanga Research - 15 Jun 2020