Post-meeting with management, we came away less upbeat about the company’s prospects. We reckon replenishment headwinds for its construction orderbook remains a drag on an otherwise promising water meter manufacturing segment (20% of earnings). Resumption of works for LRT3 is imminent and back to full swing in CY20. We cut our FY21-22 earnings by 6.5% and 8.1% respectively after cutting project margin assumptions for LRT3 and downgrade the stock to a HOLD (from Buy previously) with a lower SOP-driven TP of RM1.04 (from RM1.41 previously). Our TP implies FY20-21 P/E of 9.3x and 9.8x respectively.
We Met Up With the Management of GKent Recently With the Following Key Takeaways:
Construction. According to management, works for LRT3 will resume imminently and back to full swing in CY20. The recent arbitration between the company and MRCB is still ongoing but progress of LRT3 works are not expected to be adversely affected. Potential jobs remain regional rail related opportunities with a potential tenderbook of RM1bn (Singapore LTA track-works and Bangkok Orange Line 2nd Phase track works). Other job focus for GKent would be water infrastructure jobs (RM1.5bn) consisting of Papua New Guinea (PNG) O&M contract extension, as well as new water treatment plants in Kedah and PNG. The company’s outstanding orderbook (ex LRT3) stands at c.RM340m which translates into cover ratio of 1.22x of FY19 construction revenue (as at July 2019).
Conventional water meters. GKent’s long-term license agreement with Honeywell enables transfer of technology and associated machinery tools to the former for manufacturing high-precision water meters (V100 and V110 C-Class volumetric water meters). The agreement further grants GKent access to 15 new territories in the Asia region. Potential rollout of new products include multi-jet meters (Jan 2020) as well as D-Class volumetric meters (mid-2020) both geared for overseas markets.
Smart meters. GKent’s automated meter reading solution (a.k.a. smart meters) is undergoing pilot testing in several states with commercialisation set for CY19. We understand that the company is expected to sell 7k units of smart meter in FY20 and 140k units in FY21. Although pricing of smart meter is significantly higher than that of conventional meter (4x the price), the contribution would not be significant in the near term as the unit size is still relatively small (FY19: 2.4m unit sales of conventional meters).
Outlook. Given the heightened competition in railway construction jobs domestically resulting from downsizing and reviews, we foresee limited orderbook replenishment potential (last award in Dec 2016). To combat this, GKent is targeting to grow profit contribution from its metering division to 50% (from 20%) by 2022 and to 75% in the longer term. The company is looking for potential M&A opportunities and also may form strategic alliances to expand geographical markets and diversify products range.
Forecast. We cut our FY21-22 earnings by 6.5% and 8.1% respectively after reducing project margin assumptions for LRT3 post-guidance.
Downgrade to HOLD, TP: RM1.04. Downgrade to HOLD rating with lower SOP driven TP of RM1.04. We opine that the key overhang for GKent remains its weak construction orderbook replenishment prospects due to the dearth of railway projects. Downside risks should be cushioned by its healthy balance sheet amounting to net cash of RM0.38 per share (37% of current market capitalization), deployable through share buybacks (c.26m shares since May 2018) and decent dividend payout (40% payout ratio) translating to FY20-21 yields of 4.3% and 4.1% respectively.
Source: Hong Leong Investment Bank Research - 30 Oct 2019