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Construction Sector (CIMB Research); maintain overweight

More on MRT
According to The Edge Weekly, the proposed MRT system will cost RM36bn, 30% of which is tunnelling works, and the tenders will be based on “Swiss Challenge”. The project is still at the preliminary stage. The article highlighted several key points which are positive for the sector. However, there was a negative surprise for Gamuda as it can bid for only  the tunnelling portion worth RM10.8bn.

Should the Gamuda-MMC JV get it, it would bump up Gamuda’s RM7bn order book by RM5.4bn to RM12.4bn and enhance its FY11-12 net profit by 7-9% and its RNAV and target price by about 8%, lower than our earlier estimates. We gather that a decision is likely to be made by end-2010, which means that the project could be awarded in 1Q11 provided that the government speeds up execution over the next couple of months.

We maintain our OVERWEIGHT on the construction sector, which remains premised on the rollout of  mega jobs, reinforced by this news on the MRT project. We also maintain our Outperform calls on our top picks, WCT and  Gamuda.

The news
Over the weekend, the Edge Weekly featured an article on the new MRT system. According to sources, the project will cost RM36bn based on 2010 prices. It will involve  tunnelling and the construction of 180-200km of rail lines and stations. Of the total value, 30% is budgeted for tunnelling works.

Although the Gamuda-MMC JV mooted the idea, it will be bidding for only the tunnelling portion worth RM10.8bn due to conflict of interest. Since there are no other Malaysian contractors with tunnelling experience, foreign  contractors will qualify to bid for the tunnelling portion too.

The remaining 70% of the total cost will be up for competitive tender. The government has decided that the tender for the entire project will be on “Swiss Challenge”. The RM36bn cost represents the most expensive mega project in the nation’s history, surpassing the RM20bn development cost for Putrajaya, RM10bn for KLIA. and Gamuda-MMC’s RM12.5bn northern double tracking project.

The rationale for the new MRT system is to bring KL up to par with other developed cities, which will bring life back to the country’s capital city. Most other major cities have at least 40km of rail tracks per million people. KL’s rail infrastructure is woefully inadequate compared to other countries in the region.

Based on existing facilities (LRT and monorail) there are only 15km of tracks per million people. Singapore has hit 40km and has embarked on a plan to expand its MRT lines by an additional 140km at a total cost of $40bn  (RM94bn) or RM670m/km.

Gamuda and MMC Corp’s proposal has set an ideal target of 40% of all commuting trips in KL to be done via public transport compared with 18% currently and 50% of the public transit to be handled by rail by 2010 vs. 28% currently. The proposal involves the addition of three new lines, with two cutting across the southeast-northwest axis, which is not served by LRT now. The third is a circle that will cut across all LRT and new MRT lines to make for a truly integrated transport system.

The MRT will have a total capacity of 2m passengers/day and could further expand to 4m. The proposal for the MRT system is still at the preliminary stage and no firm decision has been made. Under the 10MP, a RM20bn facilitation fund will be set up to encourage the private sector to participate in strategic projects.

It is believed that the MRT project will be one of the beneficiaries of this fund. The project could receive up to 10% of costs (RM3.6bn) in the form of a grant from the
government.

Other players are threatening to steal the job from the Gamuda-MMC JV, with a Chinese party supposedly leading the pack. Some parties may even use political connections.

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Comments
Details are positive. The article gave more details on the proposal and highlighted several key points which are positive. The RM36bn total project value is slightly higher than the recently reported RM35bn total cost for the MRT project.

Though the article mentioned that the RM10.8bn tunnelling portion will be via an international tender, we think that the Gamuda-MMC JV has a strong chance of clinching this portion or taking a lead position as foreign tunnelling expertise is likely to be needed. Given the soil/earth conditions surrounding the KL area, the tunnelling works will not be a  straightforward engineering exercise.

Exposure for Gamuda a negative surprise. Should Gamuda secure the tunnelling portion via the 50:50 JV co., it would bump up its RM7bn outstanding order book by RM5.4bn to RM12.4bn. Working on an assumed 8% pretax margin and the reported 10-year development timeframe, the project would enhance Gamuda’s FY11-12 net profit by 7-9% and RNAV and target price by about 8%.

The impact is smaller than our earlier estimates of enhancement of 15-21% for FY11-12 net profit and 12% for RNAV as we took the entire project value of RM36bn. This is a negative surprise. According to the article, Gamuda may not participate in other packages due to conflict of interest.
 
This is contrary to earlier indications that the group should have first right of refusal given that it initiated the proposal. Another negative surprise was the concern that other players could “steal the job” from the Gamuda-MMC JV. More reasons to support implementation.

Regional comparison of railway systems as highlighted in the article gives a better perspective on the MRT proposal and support implementation of the project. We gather that a decision is likely to be made by end-2010, which means that the project could be awarded in 1Q11 provided that  he government speeds up execution over the next couple of months.

A reassurance is last week’s 10MP announcement which featured the MRT project as the mega job throughout the 5-year development period.

Valuation and recommendation
Maintain OVERWEIGHT on sector. The article highlighted more details on the MRT project, which are positive, but revealed several negative surprises for Gamuda, which could end up with a smaller share of the project. Overall, this project should be long-term positive for the construction sector if it materialises.

Though execution remains a key risk, we continue to believe that there is a good chance of the MRT system coming through as it ties in with the government’s push to improve public transport infrastructure.

A reassurance is last week’s 10MP announcement which featured the MRT project as the mega job throughout the 5-year development period. We maintain OVERWEIGHT on the construction sector, which remains premised on the rollout of mega jobs, reinforced by this news on the MRT project.

We also maintain our Outperform calls on our top picks, WCT and Gamuda. Despite the potential bad news for Gamuda, we remain positive on the stock as it still has a strong chance of clinching a sizeable chunk of the MRT project. The group is also one of the main contenders for the RM7bn LRT extension/upgrade.

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