Malaysian Resources Corp - Construction to drive growth

Potential catalyst from clinching RM2b works for Bakun Energy Transmission Grid. Malaysian Resources Corp (MRCB) has decent chances of clinching the RM2b Bakun hydroelectric dam’s power transmission line contract (to be awarded in 2010), as it has expertise in power transmission jobs. The project entails laying inland transmission lines from Bakun to Tanjung Leman in Johor, and to a power off-taker in Bentong, Peninsular Malaysia (excluding undersea cable from Sarawak to Peninsular Malaysia). Clinching the job will be a big boost to MRCB’s current orderbook of RM1.8b (excluding Penang Sentral Station), mainly contributed by construction works of Permai Hospital and Eastern Dispersal Link in Johor.

Bidding for other mega projects. We understand that MRCB is also looking to bid for jobs like extension of 2 LRT lines worth RM7b-10b and Langat 2 water treatment plant worth RM5b. Such large-scale projects would probably be shared by consortiums made up of a few established contractors. However, we understand that it is not keen on bidding for the new low-cost carrier terminal (LCCT) in Sepang.

Engineering & Construction division to drive 2009 earnings. The Group is targeting a RM400m-800m orderbook replenishment for this year. We foresee margin recovery to 3-5% from last year’s operating losses for ongoing projects this year, following the tailing off of construction jobs that have locked in higher raw material costs, and given the overall downtrend in key material costs. Management is still hoping for a potential provision write-back (about RM30m) via variation orders claims against the government for earlier engineering and construction jobs.

New property development’s earnings to be recognised in 2010. Most of MRCB’s projects in KL Sentral were delayed since last year due to the economic downturn and spike in construction cost. The Group has recently resumed new launches such as: a) Lot 348 (40:60 JV with Gapurna) of office towers and serviced apartments with GDV of RM914m, b) Lot A (CIMB Tower) with GDV of RM404m and c) Lot G parcel C and D (60:40 JV with Aseana) of office towers and hotel with GDV of RM860m. However, earnings contributions would not be significant in 2009 as construction progress is still at initial stages.

Office segment still resilient. We understand that a Korean investor is interested to buy an office tower in Lot G (Parcel C & D which consists of two office towers with GFA of 846,000sf) in KL Sentral to lease out to existing Korean companies operating in Malaysia wanting to relocate to Central Business District. We understand also that a MNC is interested to occupy 60% of Lot 348 KL Sentral with an indicative rental rate of RM7-8psf.

Still delay in proposed Penang transport hub and mixed development. MRC’s turnkey contract for the RM200m Penang Sentral Station in Butterworth has yet to start, pending issues on the land usage. The project entails MRCB venturing with Permodalan Hartanah to undertake an estimated RM2b mixed property development with a targeted completion year of 2021.

Upgrade to HOLD. We raise our fair price to RM1.28 (from RM0.97) to reflect the potentially positive newsflow of clinching mega projects, and in recognition that in the past construction cycles, MRCB’s valuation would significantly perk up ahead of ascending development expenditures (see chart on RHS). We note that MRCB features the highest beta (of 2.0) among the liquid construction companies. Our fair price is based on a 35% discount (from previous 50% discount) to RNAV of RM1.97/share, which implies a target 1.5x 2010F P/B, which is in line with its historical average P/B.