Ireka Corp Bhd (July 6, 75.5 sen)
Maintain reduce at 72 sen with target price of 70 sen: All three new contracts secured so far in 2011 — two in KL Sentral Office Towers & Hotel and the other in the City International Hospital (CIH) development, its maiden construction contract in Vietnam — are from development projects that 23%-associate Aseana Properties Ltd (APL) has stakes in. An imminent new contract valued at about US$30 million (RM90 million) is also from the CIH development.
Tenders for projects outside the group with a total value of about RM1 billion have not been fruitful so far, as Ireka is not willing to bid lower in view of project requirements and the prospects of rising cost of construction. The last non-APL project secured by the group was the RM36.2 million contract for the Bandar Indahpura, Kulai-Second Link Expressway Interchange awarded by the Iskandar Regional Development Authority in April 2010.
For existing contracts, which have a total outstanding value of about RM470 million as at end-April 2011, management guided sustainable gross margins of 7% to 10%, which will translate into pre-tax margins of 3% to 4%. These margins continue to be the norm for many private sector building projects, leaving contractors vulnerable to the rising cost of materials (steel bar prices have risen by about 10%), labour shortage, unfavourable weather conditions as well as accidents (as occurred on one of Ireka's significant projects in FY11).
The FY11 was difficult for the group as four quarters of losses accumulated to a net loss of RM11.7 million for the financial year. Key reasons were: (i) losses at APL (reclassified as an associate for the first time in 4QFY10) due to a loss from the sale of properties in 1 Mont'Kiara, Kuala Lumpur, unrealised foreign exchange losses as well as management fees; (ii) mark-to-market losses for share investment in Kinh Bac City Development in Vietnam; and (iii) delays in the completion of a significant project due to labour shortages, weather and a couple of incidents on site.
Management expects a turnaround to profitability in FY12 as APL would be able to book profit from the sale of properties in Seni Mont'Kiara, Phase 1 of which was completed in April 2011 and Phase 2 scheduled for completion in 3Q11. Barring unforeseen delays and material price spikes, the construction division will also contribute on a target billing of about RM400 million and pre-tax margin of 3%.
The Kia Peng high-end residential development in the KLCC vicinity, a 30:70 joint venture between Ireka and APL, is expected to be profitable, but the likely adoption of IFRIC reporting standards would delay profit bookings to about 2015. With APL now almost fully invested, Ireka may venture into more development projects, leveraging on its reputation as a developer of high-end, high-rise properties.
While the projected turnaround in FY12 is positive, we believe the lethargic share price performance as well as institutional interest and trading volume require stronger drivers in the form of more contract awards from both APL projects as well as private and public projects from outside the group.
There are challenges, especially in view of its outstanding order book of about RM470 million and management target of about RM400 million in construction billings a year. Tenders for non-APL projects with the required margins have so far been unsuccessful while demand for higher-end properties in Vietnam has been affected by high interest rates, tighter credit and fear of further devaluation of the Vietnamese dong.
Pending more positive news flows on new construction and property development projects, we maintain our FY12/FY14 profit forecasts as well as target price of 70 sen (based on 40% discount to realisable net asset value) and "reduce" call.
For exposure to the construction sector, we continue to prefer IJM Corp (RM6.49, "buy", target price: RM7.80), Gamuda Bhd (RM3.92, "buy", TP: RM4.51) and WCT Bhd (RM3.12, "buy", TP: RM4.19). Gamuda also offers significant exposure to the property development sector in Vietnam. — Affin IB Research, July 6
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