Tuesday, 24 March 2020


From the Editor-In-Chief of The Pelham Blue Fund

I remember having a conversation with an analyst in the middle of last year. We were discussing the prospects of Gamuda Bhd and its proposed RM6.2 billion sale of four Klang Valley highways to the Government - well, the old Pakatan Harapan government, to be precise.

My question : "Why is this deal good? They're going to lose a Penang-sized chunk of revenue and damn vital recurring income source, bro"

The analyst : "But you see, this is good for everyone. Once sale finalised, got big special dividend coming bro. Everybody's happy"

Me : "So now you're saying people are buying the stock just to get the dividends? And after the sale they're going to put all their chips on all the Penang Transport Masterplan stuff?"

Analyst : "Yes, pretty good short term yields, isn't it?"

Me : "But how about the lost revenue and long term recurring income..."

Analyst : "You obviously don't understand, so let me explain to you again..."

 Source : company filing

And he did. I enjoyed getting thorough explanations without having to do much but listen intently. I also tend to see the explainer's biases. Indeed, the sale is a good move, if you look at it solely in a short term context. Fat dividends tend to do that, and you know how fund managers are always under severe pressure to meet their KPIs.

Before I get into the details, you're probably wondering why I'm talking about GAMUDA now. It's because the deadline to finalise this highway takeover agreement is going to end on 31 March, 2020.

The second bit is that in case you haven't noticed, we had a change in government recently. This deal has nothing to do with the new government. It looks unlikely that this would be pushed through.

From a taxpayer and local citizen perspective, I've always thought this deal was a 'what's going on?' kind of transaction. Call me naive, but from a shareholder's perspective, I fail to see the long-term economic benefit for the company.

The logic for the rakyat also escaped me : so, in order to reduce the toll burden of Klang Valley motorists, the Government was going to buy the highways and grow its overall debt burden, which in turn will likely cost Malaysian taxpayers (all over the country) more in the long run?

And the company's giving up a stable income source, or to put it indelicately, its main cash cow?

How fat is the cow? In GAMUDA's last full financial year, the concession business generated revenue of RM496 million. It's pretax profits from that? RM303 million. The business generates 7% of GAMUDA's total revenues but a full one third - 33% - of its pretax profits. You can see why investors like highways; the concession business has a pretax margin of sixty percent.

Last year, the promise of a big payoff led to intense interest to buy the shares. One estimate put the potential special dividend - one-off payment from the proceeds of disposal - of between 48 and 96 sen per share

Below is GAMUDA's share price performance from February 2019, when the takeover was announced, to February 2020, just before the Pakatan Harapan government's collapse. That's a 52% gain in the stock.

And... that was the top. Below is the seubsequent Perikatan Nasional period stock performance (late February onwards) looks like this. A 40% decline.

This highway deal is likely dead in the water anyway as it was the previous MOF's baby. The current government has more pressing things to commit funds on to save the economy and prevent a recession.

It's not just that the highway takeover does not make sense at a fundamental level; this was no impediment to many 'successful' transactions in the past.

But structurally it was never meant to happen in the first place. When you have too many moving parts (multiple listed entities, cross-shareholdings by institutional funds, related party transaction hurdles, regulatory scrutiny, the political angle, etc), that's when a major deal crumbles. Just like any of the proposed bank mega mergers in the last decade.

The baby was... ugly. It's not loved, because you couldn't exactly see if the rakyat benefits from this proposed takeover of four highways. There was the whole brouhaha with the proposed PLUS sale that amounted to nothing except oh, wait for it... cheaper tolls now in return for having to pay tolls for another 38 years.
For this highway deal, I can understand that at least three parties want it to happen : the management, fund managers holding GAMUDA, and the old MOF. Maybe the intent was to take the cash and pivot towards Penang. 

As for the rest, I really don't know, but if one has a five-to-ten year viewpoint that isn't clouded by a special dividend, literally everybody else would probably say "I don't mind owning some highways to get me through tough times". Hardly a radical viewpoint.
Look, imagine if your plate of nasi lemak is cut by half. Some random guy - me - comes over and takes away your sambal, eggs and anchovies, leaving you with nasi lemak that's only fit to serve on certain airplanes.

Highways contribute RM200 million plus to GAMUDA's annual net income. Without that, how's your nasi lemak going to look?

What's going to fill the hole? Your income proportion out of revenue from digging holes is much less. This is a company that has massive tunnel boring machines - they should know all about digging and filling holes.

The PTMP is effectively on ice without federal funding assistance, so let's not go there. But I would not want realised present value income (that dividend) in exchange of lost future income that is likely worth multiples.

Bersenang dahulu, bersusah kemudian? No thanks.

The highways is a cash flow lifeline and income stabiliser, and will help GAMUDA weather the current economic turmoil and incredibly lousy sentiment in the construction sector right now. 

The stock was hit by a triple whammy recently - the new government taking over, already weak sector sentiment, as well as the sudden shock in the stock markets. When a stock is hit especially hard, and probably unfairly, it makes our ears prick up. Perhaps there's an artificial mispricing situation there?

As an observer on the sidelines, it made me keen to explore if GAMUDA's worth an investment. And it might very well be at current prices.

Recent fear-driven selling likely has led to the shares being undervalued, and we do not mind collecting some. From our own estimates, we have a fairly conservative target of RM3 and above for the stock over the next 12 months.
The economy needs boosting somehow. Infrastructure spending is the easiest avenue to spur growth; there will be some slices for the company somewhere. Name us another construction company that is ahead in line for major projects, or anyone in the construction business who stand a chance to be more profitable. 

I do not mind having a stake in a company that can still record hundreds of millions of ringgit in net income during probably the worst period for the Malaysian economy  in at least 15 years.

Don't feel bad about GAMUDA not taking off anytime soon in Penang. It's got other things going for it. What it needs now is to attain new projects to replenish its orderbook, which is massively dominated by existing MRT2 related obligations. This will be a headache for now, but over the longer term, it will survive and thrive.

Source : AmInvestment Research

To summarise:

First in line for any significant rail transport infrastructure projects, although don't expect the margins to be exciting.

Earnings shortfall from construction/property segments cushioned by highways contribution.

Dividend yield upside of 4.5% at current stock price, according to one analyst estimate.

To be frank, keeping the highways would be the best thing could happen to them right now. 

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