This article first appeared in The Edge Financial Daily, on April 20, 2016.

IJM Corp Bhd 
(April 19, RM3.53)
Upgrade to buy with higher target price (TP) of RM4.00: We revisit our profit before tax (PBT) marginal assumptions on IJM Corp Bhd due to the intensifying application of Industrialised Building System (IBS), which currently accounts for 30% to 40% of its construction projects. Our assessments include factoring in the cost savings that IBS could potentially contribute to the bottom line of the concrete manufacturing, property and construction segments.

We reduce our total cost to revenue estimates from 72% to 69% to reflect the cost advantages of applying IBS. Furthermore, we expect revenue contribution from the concrete manufacturing segment to rise from 17% to 25%. As a result, our overall construction PBT margin estimates for financial year 2017 (FY17)/FY18 increased from 8.9% to 10%. Note that IJM’s total cost to revenue has shown a decreasing trend for the past five years except 2011, when the Economic Transformation Programme (ETP) was just launched. Evidently, IBS has proven to reduce costs and positively impact the bottom line of construction giants such as Skanska, Hochtief and Bechtel.

We reckon IJM’s PBT would increase through the reduction of costs and the increase of concrete manufacturing activities through IBS. Thus, we expect IBS application to expand due to diffusion of construction technology going forward. Segments such as construction (18.1% of PBT) would potentially increase its PBT margin by 1.1% and supported by an estimated revenue growth of 8% in concrete manufacturing (12.3% of PBT) in FY17/FY18. However, should there be any intermittent impact on the quarterly results, it will be due to temporary blips from gaps in between projects. All in, we expect IJM’s PBT margin would be lifted by 10%.

Premised on the above, we remain sanguine about the prospect of IJM’s application of IBS. Whilst IJM’s top-line growth would not be swayed significantly, the impact can be zeroed in on to the bottom line as the average five-year total cost of 72% can be trimmed to 69%. Currently, the application of IBS in Malaysia is still at its infancy stage due to lower construction materials and tender negotiations. However, we opined that by “crossing the chasm” of using IBS in its construction processes and products, IJM could forge its competitive advantage in the long term for projects under its current order book of RM7 billion or the upcoming infrastructure projects under Government Transformation Programme 3.0 and ETP 3.0. Hence, we believe that the impact of its application going forward through the reduction of construction cost per square metre in its projects.

As we argued in our previous report (Feb 15, 2016), we hereby rerate IJM predicating on the impact of its application of IBS that we estimate would expand from 30% to 40% currently to 50% in FY17/FY18 onwards. 

It is notable that IJM’s potential internal cost structure improvement is a boon to its forward earnings potential. Thus, we raise our FY17/FY18 normalised earnings forecasts by 11% to 13% and revise our TP from RM3.56 to RM4.00 per share, which equates to an implied price-earnings ratio of 11 times. Accordingly, we upgrade our recommendation from “neutral” to “buy”. — MIDF Research, April 19