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Sunway (OSK Research); Buy, target price RM1.96

Initiating Coverage - Sunway Holdings
Ripe for the Picking


We have a positive outlook on the domestic construction scene and view Sunway as a strong proxy. Its established track record should give Sunway the clout to secure repeat jobs from existing clients. We also expect more jobs to flow from overseas markets such as Abu Dhabi, India and Singapore. Sunway’s property earnings should be anchored by its Singapore developments, for which there has been strong take-up. We initiate coverage on Sunway with a BUY rating and RM1.96 TP.

Domestic outlook. Sunway has tendered for RM16.1bn worth of jobs and boasts a historical success rate of 10%-15%. We believe that domestic contracts awarded to listed contractors in 2010 may exceed last year’s RM10bn. Some 77% of Sunway’s targeted jobs are in Malaysia. Among the potential jobs are: (i) the LCCT building (RM750m-RM850m) and satellite terminal (RM400m-RM500m), for which Sunway has been prequalified, and (ii) Legoland Theme Park (RM700m), given its experience with 2 theme parks earlier.

Repeat jobs. We understand that Putrajaya Holdings SB intends to call for RM1bn worth of tenders in the coming months and SunCity has RM700m-RM800m worth of projects in the pipeline. In our view, Sunway should have a good chance of success with these developers as it has previously conducted works worth RM750m-RM780m for each of the two.

Foreign contracts. Currently Sunway is constructing Phase 1 of the USD25bn Arzanah Development. As tenders for Phase 2 (RM1bn) could be called next year, we expect Sunway to leverage on its relationship with Capitala to secure a slice of the pie. In India, we see Sunway securing some road jobs given the sizable rollouts being planned, a shortage of local capacity and the company’s track record (RM1bn completed). We also believe Sunway can land more precast concrete structure jobs in Singapore, driven by the nation’s plans to ramp up construction of HDB flats.

Property developments. Sunway has an effective GDV balance of RM1.9bn, out of which RM750m-RM800m will be launched this year. We see property earnings anchored by the Boon Keng (SGD421m) and Toa Payoh (SGD680m) developments, in which it has a 30% stake. Both developments are nearly sold out and construction has commenced. Sunway also plans to launch its Jln Senang development (SGD420m, 30% stake) this year.

Initiate with BUY. We have a 3-year earnings CAGRf of 27.5%. Sunway is also disposing of some non-core assets to achieve a net gearing target of below 50%. Large cap contractors under our coverage are now trading at 14.7x CY10 earnings. Given its higher net gearing, we are ascribing a lower earnings multiplier of 12x to Sunway’s partially diluted FY10 EPS, from which we derive a TP of RM1.96.

BACKGROUND
Humble beginnings. Sunway Holdings Bhd’s (Sunway) history goes back more than 3 decades when it started as a humble local tin mining and quarrying company. It was listed on the Main Board of Bursa in 1984 under the name Sungei Way Holdings. Over the years, Sunway nurtured its quarrying business and also ventured into construction.

altCrisis strikes. In the mid-90s, Sunway began to raise more debt to finance its acquisitions and overseas expansion. The bulk of the debt came from the issuance of a USD110m Euro convertible bond in 1996. Its fortunes turned when the 1997 Asian financial crisis struck, as the group reeled from the double whammy impact of slowing construction activities and piling debts. In efforts to reduce its net gearing, Sunway embarked on various restructuring exercises such as disposing of its quarries and recapitalising its balance sheet.

Not so silky. After the Asian financial crisis, Sunway suffered another blow in relation to its 36.2% stake in SunInfra (now known as SILK Holdings (NR)), the toll concessionaire for the Kajang SILK Highway. Due to lower than expected traffic numbers coupled with high interest expense, SunInfra ran into losses which were equity accounted into Sunway’s bottomline. In 2008, Sunway disposed of its entire stake in SunInfra.

Rising from the ashes. Having survived the Asian financial crisis and debacle involving SunInfra, Sunway has emerged a stronger entity. Today, it has businesses in construction, quarrying, trading & manufacturing, building materials and property development spanning 10 countries.

Management team. Sunway is spearheaded by Executive Chairman Tan Sri Dr Jeffery Cheah, who holds a 45% stake in the company. He also holds a 40% share in property developer Sunway City (“SunCity”) (NR), thus making the two entities “sister companies”. We understand that most of Sunway’s senior management has been with the company for more than a decade.

INVESTMENT THESIS
Our investment thesis on Sunway is simple: we remain positive on the outlook for domestic construction and view Sunway as an excellent proxy. As Sunway enjoys a good reputation among its clients, it is able to secure repeat contracts. We also expect more overseas contracts from countries such as Abu Dhabi, India and Singapore. For its property division, we see sales remaining strong, underpinned by the domestic economy’s recovery. Meanwhile, the quarries, trading and building materials divisions should continue to show decent growth.

CONSTRUCTION DIVISION
Eyes on more jobs. Sunway has an orderbook balance of ~RM2.5bn, which we estimate is good for 2 years. Historically, Sunway secured jobs from a diversified pool of clientele in the government and private sectors locally and overseas, which help make it less dependent on jobs from a particular segment. For example, although 2008 was a drought year for domestic contracts, Sunway managed to secure RM2bn worth of jobs, thanks to contracts from Abu Dhabi and Singapore. Management has guided for RM16.1bn worth of tenders in the pipeline and a historical success rate of 10%-15%. Our projections assume RM750m in new jobs for FY10 (RM263m achieved YTD) and RM1bn pa for FY11-12, which is still below its 5-year historical average of RM1.15bn pa.

altPositive sector outlook. We are OVERWEIGHT on the Malaysian construction sector underpinned by positive news flow in the coming months. Government development expenditure is expected to remain at a record high of RM53.2bn in 2010 (RM53.6bn in 2009). In tracking the domestic construction awards announced on Bursa, we found that the jobs flow YTD (i.e Jan-April) has increased 5.2% y-o-y. We believe that the total contracts awarded for 2010 can easily surpass the RM10bn achieved last year. Recently, 3 Private Finance Initiatives (PFIs)-based projects worth >RM500m were dished out. This signals that the long awaited PFI projects are gaining traction, which is positive for the sector as more jobs can be implemented. The unveiling of the 10MP in June should also be positive for the construction sentiment. Sunway has positioned itself for a pick-up in domestic construction, with RM12.4bn worth of targeted tenders in Malaysia.

Beneficiary of small jobs. YTD the average size of domestic contracts bagged by listed contractors is RM155m, which implies that most jobs are mid-small sized in nature. We believe Sunway is one of the main beneficiaries as most of its domestic jobs are worth RM110m on average.

Participating chance with LCCT. Five contractors are said to have been shortlisted for the Low Cost Carrier Terminal (LCCT) building (RM750m-RM850m) and satellite tower (RM400m-RM500m). The contractors are Sunway, IJM Corp (BUY, TP: RM5.45), UEM-Bina Puri JV, Gadang-PPC JV and AHT Norlan-Carriage JV. Along with IJM, we think that Sunway has a decent participating chance in the project. Sunway has worked with Malaysia Airports Holdings (TRADING BUY, TP: RM5.50) on various structures at Subang Airport (RM120m). Track record aside, we believe that Sunway has the power to make competitive bids which is a key criterion for securing jobs on open tender. For example, Sunway made the 2nd lowest bid for the LCCT EW1 package (RM363m).

altGood track record in Putrajaya. In the past 5 years, Sunway has been awarded RM770m worth of contracts from Putrajaya Holdings SB, the master developer for Putrajaya (Malaysia’s government administration centre). The developer intends to call for RM1bn worth of tenders comprising office towers, commercial blocks and residential units in Putrajaya in the coming months. It has said that names like Sunway, IJM, UEM Builders, Ahmad Zaki (BUY, TP: RM1.16) and Ireka Corp (NR) would be invited to put it their bids. We believe Sunway stands to get a slice of the pie given its vast experience there.

SunCity’s preferred contractor. Sunway is the preferred contractor for its sister company, SunCity, a property developer. As preferred contractor, Sunway gets to match the lowest bidder in a tender. So far, Sunway’s success rate in SunCity projects is about ~50% although the latter employs the open tender system. Various development projects in the pipeline for SunCity are collectively worth RM700m-RM800m, including Sunway Pyramid’s mall extension, a corporate tower, Sunway college extension and some residential units. We opine that Sunway should be able to gain a share of the construction works given its track record with SunCity. Over the last 5 years, Sunway has bagged RM758m worth of construction works from SunCity.

altLegoland job up for grabs. In March, Iskandar Malaysia’s developer Iskandar Investment called for tenders for the construction of Legoland Malaysia Theme Park (RM700m). The 2 packages being open for tender comprise (i) primary infra, and (ii) service & admin building, car parks and substation. We see Sunway possibly winning some packages involving the theme park construction. Sunway had previously constructed the Sunway Lagoon Theme Park and the Lost World of Tambun.

altMore from Arzanah. Management is positive on prospects in the Middle East, particularly Abu Dhabi given the higher margins and the emirate’s tax free status. In September 2008, Sunway together with Abu Dhabi-based Silver Coast LLC were awarded the construction works for Rihan Heights worth RM1.6bn (RM1.2bn outstanding). Sunway has a 60% stake in the job and profits will be recognized as “contributions from JV entities” (equity method). Rihan Heights comprises 5 blocks of high end condos, townhouses and a clubhouse, representing Phase 1 of the Arzanah Development. Arzanah is a joint development between Mubadala (owned by the Abu Dhabi Govt) and CapitaLand (NEUTRAL, TP: SGD4.32). We gather that tenders for Arzanah’s Phase 2 could be called next year and believe that Sunway could potentially secure some works given its existing relationship with the developers.

altIndian road jobs. India intends to construct 53,639km of roads in 7 phases from now up to 2012 which will cost USD66bn. Some USD20bn worth of road contracts are expected to be awarded by 1H 2010. While India’s road construction target is at 20km/day, we gather that the current rate is only 50% due to land acquisition issues. The Malaysian contractors we contacted feel that Indian contractors can only hit 60% of the daily target due to capacity constraints. This implies that the balance 40% must be fulfilled by foreign contractors. While margins in India are rather thin, we gather that Malaysia’s Construction Industry Development Board (CIDB) is currently in negotiations with the National Highway Authority of India (NHAI). Under the proposed framework, NHAI will allocate some of the road projects to CIDB, which will then decide how to dish them out to Malaysian contractors.

Vast experience in India. We feel that Malaysian contractors such as Sunway have the advantage in securing these Indian road jobs given their experience in the country. Sunway has completed RM976m worth of roads in India so far, with RM138m outstanding. Sunway intends to bid for RM3bn-RM4bn worth of jobs there.

Precast potential. The Singapore Government intends to build more than 12,000 units of Housing Development Board (HDB) flats over the next 1 year to replenish existing inventory, which has been sold down. We understand that it is mandatory to use precast concrete structures for HDB flats given their efficiency (less labour intensive). We gather that some SGD700m (~RM1.6bn) worth of precast concrete will be needed to fulfill Singapore’s HDB flat construction target. Sunway is a key beneficiary from this as it has a plant in Tampines with a capacity of 350-400m3/ day (equivalent to ~SGD100m pa in value). Currently, Sunway has a contract to supply precast concrete worth RM550m (72% outstanding) to various HDB developments.

PROPERTY DIVISION
altTargeting more launches. Sunway’s property developments have an outstanding GDV of RM1.9bn based on its effective stake. All its local developments are located in the Klang Valley. We expect domestic property sales to remain strong this year, underpinned by a recovering domestic economy. OSK-DMG’s economics team projects Malaysia’s GDP to grow by 7% in 2010. Management said it expects to launch RM750m-RM800m worth of developments this year.

Strong sales under DBSS. Sunway’s exposure to the Singapore property market is via its 30% stake (70% by Hoi Hup Group) in two Design-Build-Sell Schemes (DBSS), namely the City View @ Boon Keng and The Peak @ Toa Payoh. Both developments are public sector housing comprising HDB flats. We expect strong earnings from these 2 developments over the next 2 years, with profits equity accounted for under “associate contributions”. Sunway’s portion of the unbilled sales for both developments now stands at RM543m. City View has a GDV of SGD421m and has been fully sold, with construction progress now hitting 80%. On the other hand, The Peak’s GDV stands at SGD680m and is 90% sold. Its construction has reached 20% and momentum should further pick up in the coming months.

Singapore private housing venture. Given its success with the first two public housing developments, Sunway (together with Hoi Hup Group) have decided to venture into Singapore’s private housing market. Earlier this year, it acquired 4.75 acres of land in Jalan Senang, which will be developed into 8 blocks of 12-storey apartments comprising 500 units in total. The estimated GDV is SGD420m and Sunway intends to launch the entire portion this year. Management has guided for the development’s profit margins to come in at 15% (at PBT level). We estimate that the bulk of the earnings recognition for this development will take place in FY11-12.

QUARRY DIVISION
altDomestic operations. Sunway re-entered the quarry business in 2005 with 3 quarries. Today, it has 7 quarries and 7 asphaltic plants across Peninsular Malaysia. The quarry plants are used to crush the rocks from its quarries into aggregates which are then either sold directly or sent to the asphalt plants to be processed into asphaltic premix. We understand that prices of ¾ inch aggregates in Malaysia have been on the uptrend and currently stand at RM25/tonne. Utilisation rates for Sunway’s quarry plants now stand at ~60%, suggesting that there is upside potential once demand picks up fuelled by stronger construction activities. Within the Klang Valley, Sunway has a 10% share of the market for aggregates and 20% for asphaltic premix.

Foreign operations. Sunway also operates 2 quarries in Hanoi and Ho Chi Minh City, Vietnam with a monthly production of 140,000 tonnes and capacity of 210,000. The aggregates from these quarries are mainly used to produce ready-mixed concrete. In 2008, Sunway secured a contract for the annual supply of 1m tonnes of aggregates for 5 + 5 (optional) years to the government of the Republic of Trinidad and Tobago. Since it commenced operations in mid-2008, only 0.5m tonnes have been delivered, implying that > 1m pa must be fulfilled in the coming years. Selling prices in the republic are at RM54/ tonne, which is about 2x the price in Malaysia.

TRADING DIVISION
altSunway’s trading division comprises the following sub segments:

  • Hoses & fittings: This sub segment is the main contributor to the trading division. Its hydraulic hoses are sold under its own brand, “SunFlex”. In Singapore, “SunFlex” has a 50% market share for hose replacement, particularly in the O&G and marine sector.

  • Heavy equipment parts: Products include undercarriages, undercarriage frames and engine parts under the brands “SunTrak” and “FP Diesel”.

  • Heavy equipment: Mainly equipment for construction and industrial uses (e.g crawler drills, concrete pump, wheel loaders, crushers and generator sets).

BUILDING MATERIALS DIVISION
altSmall but steady. The building material division is Sunway’s smallest. We expect contributions from this division to be about 5%-6% of group revenue. The sub segments in this division comprise:

  • Pipes: Sunway has a 45% share in the domestic pipes market. It currently has an annual production of 41,000 tonnes and is targeting to achieve 52,000 tonnes. The pipes sub segment contributes 50% to the entire building materials division.

  • Pavers: This product is commonly used along pedestrian walkways. Sunway has an annual production of 1.8m m2 with a target of 2.4m m2 and has been increasing its market share in China, Australia and Brunei. Pavers make up 40% of the building materials division.

  • Wall panels: Mainly sold in Malaysia and Singapore. Contributes 10% to building materials.

FINANCIAL HIGHLIGHTS
altLet bygones be bygones. We won’t deny it, but Sunway’s earnings track record has been rather bumpy. Losses in FY02 were mainly due to impairment of various items amounting to RM143m. After 2 decent years of profits from FY03-04, Sunway was again in the red from FY06-07 as a result of losses from then associate SunInfra (36.2% stake). In 2008, Sunway disposed off its stake in SunInfra and has started clean since. Moving forward, earnings growth for FY10-12 will be underpinned by the construction and property divisions. We also expect bigger contributions from its associates & JV entities mainly arising from works at Arzanah and its Singapore property ventures. All in all, we forecast a 3-year earnings CAGRf of 27.5%. The upside to our estimates could potentially be driven by stronger than expected contracts flow, better property take-up rates and higher margins.

altTrimming its net gearing. Sunway’s net gearing has come off substantially from 269% in FY02 to 63% currently. In efforts to further cut its net gearing, Sunway has begun divesting its non-core assets such as Plaza Masalam (RM74m) and Sunway Hanoi Hotel (RM59m). The company has identified another RM120m worth of such assets that will be progressively sold. These include Wisma Mas (RM40m) and some portions of the Subang Square (RM36m). Conversion of its outstanding warrants (~246m @ RM1.30 exercise price) would raise another RM320m in cash. Sunway is targeting to achieve a net gearing ratio of below 50% (currently 63%). Without factoring in the asset sales and warrants conversion, Sunway should hit this target in FY11 mainly from cash collections from its construction and property developments.

VALUATION & RECOMMENDATION
Initiate with BUY, RM1.96 TP. Large cap contractors (market cap > RM1.5bn) within our coverage are currently trading at 14.7x CY10 earnings. Given Sunway’s higher net gearing, we are ascribing a lower earnings multiplier of 12x its FY10 EPS, which translates into a 17.2% discount to its peers. As Sunway has a sizable number of warrants and ESOS relative to its current share base, we have made the assumption that that 50% of these were converted, to arrive at our EPS (i.e partial dilution). We initiate coverage on Sunway with a BUY rating and RM1.96 TP.
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