The Ministry of Finance announced yesterday that the Government has terminated MMC-Gamuda’s contract to build the underground portion of the MRT Line 2 (KVMRT2) after the two parties failed to reach an agreement. This came in as a negative surprise as we believed earlier that the underground works, together with the above ground works, to be scaled down rather than outright cancellation. The KVMRT2 underground works constituted RM5.5bn or c.92% of the Group’s outstanding ordebook of RM6bn, which would adversely impact Gamuda’s construction earnings in the near term with the cancellation and absence of new jobs. However, we understand that the Government accepted an offer made by MMC-Gamuda to complete the above-ground portion of the MRT2 project as a turnkey contractor (from project delivery partner or PDP model) at the cost of RM17.42bn, or 23% reduction from original contract value of RM22.64bn which is quite close to Management’s guidance of up to 25% reduction. All told, we cut our FY19-21 earnings by 30%/21%/20% respectively and revised our SOTP-derived TP to RM3.00 (from RM3.80 previously) with unchanged c.20% discount in view of the derating catalysts. Maintain Neutral.

• KVMRT2 contract revisions. We understand KVMRT’s current overall PDP and underground completion is now at 28% and 37% respectively. Finance Minister Lim Guan Eng was reported to say that all unfinished underground work will be re-tendered via an international open tender process as the Government felt it could achieve “further significant savings” compared to the offer made by MMC-Gamuda. We do not discount the possibility of Gamuda to bid again for the underground contract again and could have cost advantage as it already has the boring machines and project knowledge. That said, costs could be escalated with the surprise contract cancellation due to idling resources on site but we believe Gamuda should be getting compensations. As for above ground packages, works to be continued with savings achieved through a reduction in cost and rationalisation in work scope without cancelling any of the above-ground stations. We believe that project margins should be largely unchanged from PDP model to fixed price turnkey model.

Source: PublicInvest Research - 8 Oct 2018