This article first appeared in The Edge Financial Daily on October 15, 2019

Gamuda Bhd
(Oct 14, RM3.77)
Maintain underweight with an unchanged fair value (FV) of RM2.84: We maintained our “underweight” call, forecasts and FV of RM2.84 based on Gamuda Bhd’s sum-of-parts (SoP), valuing its construction business at 10 times forward earnings, in line with our benchmark forward target price-earnings of 10 times for large-cap construction stocks.

During the Budget 2020 announcement last Friday, Finance Minister Lim Guan Eng, in his budget speech, said “the Cabinet had approved the proposed offer to acquire four Klang Valley highways — the Shah Alam Expressway, Damansara-Puchong Expressway, Sprint Expressway and SMART Tunnel — to be funded via government-guaranteed borrowings”.

Our forecasts had assumed the sale of these Gamuda toll road assets to the government to be completed in January 2020, hence Gamuda only recognises contributions for six months from the highways in financial year 2020 forecasts (FY20F), and none from FY21F. Our SoP valuation for Gamuda also reflected proceeds of RM2.36 billion that the company is to receive from the disposal.

To recap, while we believe Gamuda is getting a fair deal concerning the disposal — with the discounted cash flow valuation at a discount of about 6% based on our estimates, we are mindful of a change in Gamuda’s earnings profile after the disposal. With reduced recurring toll road earnings that make up about 35% to 40% of Gamuda’s total earnings, the company’s earnings’ defensiveness will be eroded, resulting in a higher risk premium.

Gamuda is searching for new businesses with recurring incomes to fill the vacuum, believing the RM46 billion Penang Transport Master Plan (PTMP) is a good fit as it could generate a recurring project delivery partner (PDP) fee for more than a decade.

Unfortunately, the PTMP project was not mentioned in the Budget 2020 speech, meaning slim chances of it getting the federal government’s financial assistance, and neither the Mass Rapid Transit 3 (MRT3) project that should have sustained Gamuda’s construction earnings after the MRT2’s completion in 2022.

We maintained our view that construction stocks’ valuations, including Gamuda’s, have run ahead of their fundamentals amid the euphoria sparked by the recent revival of the East Coast Rail Link (ECRL) and Bandar Malaysia projects, more so when Gamuda may not even participate in the ECRL project.

We believe with the still-elevated national debt, the government has no choice but be remain committed to fiscal prudence, meaning the ECRL project’s revival could be a “zero-sum game” as it impedes the government’s ability to implement other public infrastructure projects.

We are sensing Gamuda’s high “concentration risk” in the PTMP project as well. That is if the project fails to get off the ground in a timely manner — in the second half of 2020 as guided — or Gamuda given a reduced role in the project considering the PDP model is no longer favoured by the federal government, as manifested in the PDP model’s cancellation in constructing the Light Rail Transit 3, MRT2 and Pan Borneo Highway. We are also mindful of the potential hefty initial “school fees” that Gamuda may have to pay to gain a foothold in the Australian construction market. — AmInvestment Bank, Oct 14