This article first appeared in The Edge Malaysia Weekly on June 4, 2018 - June 10, 2018

ONE of the giants of the local construction industry, Gamuda Bhd has been involved in infrastructure developments in the country over the past two decades or so — after the likes of United Engineers Bhd were laid low by the Asian financial crisis of the late 1990s.

With its expertise in tunnelling, especially through the limestone formations of the Klang Valley, Gamuda has carved out a niche for itself in the development of public rail facilities.

Over the last 10 years  construction players, including Gamuda, have benefited handsomely from public spending on infrastructure — from MRT 1 connecting Sungai Buloh and Kajang, to the extension of the Ampang-Kelana Jaya LRT and the ongoing construction of MRT 2 connecting Sungai Buloh and Putrajaya via Serdang and the LRT 3.  Thus, when Prime Minister Tun Dr Mahathir Mohamad announced the scrapping of the Kuala Lumpur-Singapore high-speed rail (HSR) on May 30, Gamuda’s share price plunged 23% to RM3.18.

The previous government had appointed MRCB-Gamuda and YTL-Tabung Haji consortia as the project delivery partners (PDP) for the KL-Singapore HSR. The project was estimated to cost RM110 billion.

A day later, the prime minister announced that the MRT 3 will also be scrapped, citing the high cost of RM45 billion.  That made it imprudent to undertake the project now, given the high government debt-to-gross domestic product ratio of over 80%.

The scrapping of MRT 3 was seen as another blow to Gamuda,  which together with MMC Corp Bhd and George Kent Bhd (GK),  was expected to be awarded the turnkey contractor job for the project.

MRT 3 requires extensive tunnelling and the market had expected Gamuda to secure the job.

“The question right now is about Gamuda’s job replenishment. A large chunk of its construction job replenishment was expected to come from these two projects,” says Tan Siang Hing, an analyst at PublicInvest Research.

“Previously, it was targeting an average job replenishment per annum of RM8 billion to RM10 billion, with a large chunk of it coming from rail projects. Now that the rail projects are no longer there, will Gamuda be able to maintain that level of job replenishment?” he asks.

In a May 31 report, Tan says that with the cancellation of the HSR and MRT 3, his earnings estimates for Gamuda are likely to be revised downwards pending clarification from management of its plans going forward.

“We believe Gamuda has to re-strategise its focus from rail projects currently to other projects, and maybe even look at overseas opportunities, with about RM100 billion [worth of projects] already cancelled by the new government only three weeks after the general election,” says Tan.

Securing one of the two turnkey contractor jobs, would have got the MMC-Gamuda-GK consortium 50% of the estimated cost, or about RM20 billion. Gamuda’s 40% stake in the consortium would provide an economic benefit of RM8 billion.

If the project had not been cancelled and was awarded to the MMC-Gamuda-GK consortium, it would have covered Gamuda’s entire annual job replenishment, say analysts.

Gamuda’s other businesses are also expected to be affected by the government’s election promises.

Pakatan Harapan had promised to abolish tolls while the water restructuring exercise in Selangor will continue with the acquisition of Syarikat Pengeluar Air Sungai Selangor (SPLASH).

Gamuda owns a 40% stake in SPLASH, which analysts value at RM994 million to RM1.24 billion, based on one-times book value.

However, if the state government acquires SPLASH, observers say it is unlikely to make such an offer. The last offer was barely RM250.6 million. The new government’s offer might not be that low, but against the backdrop of a tight public budget, the chances pf SPLASH clinching a sweetheart deal are slim.

As for the toll concessions, Gamuda owns a 43.8% stake in Lingkaran Trans Kota Holdings Bhd (LITRAK). As at last Friday, LITRAK’s shares were traded at RM4.26, valuing the concession holder of the SPRINT Highway and the Damansara-Puchong Highway at RM2.25 billion.

This means that if the federal government takes over LITRAK at market value, Gamuda stands to get RM985.5 million. However, the federal government would also have to terminate the toll collection agreement and compensate the bondholders.

In the unlikely event of a unilateral termination of the toll collection agreement, Gamuda, as the single largest shareholder of LITRAK, would have to bear the loss of future earnings.

For the first six months ended Jan 31, water and expressway concessions contributed RM257.6 million, or 7.4%, to Gamuda’s total revenue and 42.3% of the group’s profit before tax of RM527.64 million.

The possible adverse effects of the new government’s policies have caused analysts to readjust their target prices and calls on Gamuda.

“Gamuda’s exposure to rail projects is now adversely affected, needless to say. In addition, its highway concessions are also under threat given the new government’s intention to abolish toll collections and acquire these highways via the appropriation clauses. With market fears about the former confirmed and the increasing uncertainties surrounding the latter, we are compelled to lower our call to “neutral” from “outperform” in the light of increasing derating catalysts,” PublicInvest Research’s Tan says in a May 30 research note. The research house revised downwards its target price for Gamuda to RM4.30 per share from RM6.20 previously.

Joshua Ng of AmInvestment Bank downgraded the stock to “hold” from “buy”, with a lower target price of RM3.89.

Kenanga Research maintains its “outperform” call on Gamuda with a lower target price of RM5.50 from RM5.65 previously. It believes the company will remain one of the top picks in the construction industry despite the uncertainties.

Despite the scrapping of the HSR and MRT 3 projects, Gamuda’s outstanding order book still stands at a comfortable RM6.9 billion with three-year visibility. Its vast experience in tunnelling will also stand it in good stead for future infrastructure contracts.

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