E&O expected to appoint reclamation contractor soon

Eastern & Oriental Bhd (July 14, RM1.79)

Initiate with buy and a target price (TP) of RM2.62: We initiate coverage on Eastern & Oriental Bhd (E&O) with a “buy” call and a TP of RM2.62, based on a 40% discount to revalued net assets valuation (RNAV). We expect E&O to appoint a reclamation contractor for its 760-acre (307.56ha) Seri Tanjung Pinang Phase 2 (STP2) project this month, locking in the reclamation cost. E&O is negotiating to secure a partner to take an equity stake in this project and partially unlock the value of the STP2 land reclamation rights. Our blue-sky RNAV per share of RM6.76, valuing its net land area of 517 acres in STP2 at the current market price of RM500 per sq ft, implies nearly a quadrupling of its market capitalisation.

E&O has established a niche and strong track record in luxury home developments among local and foreign buyers. Its branding is enhanced by owning the Eastern & Oriental Hotel in Penang, which is a luxury all-suite heritage hotel. E&O has planned property launches worth RM2.1 billion in financial year 2016 (FY16), and has achieved presales of RM450 million for the first quarter of FY16 ending March 31, 2016.

E&O is currently evaluating the tenders for the STP2 reclamation project submitted by four foreign contractor-led consortiums and conducting final negotiations, before awarding the contract to the winning consortium. Assuming a conservative internal rate of return (IRR) of 10% for STP2, our estimated RNAV per share of E&O is RM4.37. But the fall in oil and building material prices could lead to lower overall costs than the current estimate of RM4 billion, and enhance the IRR for the project and E&O’s RNAV.

The management team is proactive in managing its land bank portfolio and has realised attractive gains from land sales over the past year. E&O clinched a deal to sell a piece of land with a car showroom in Sungai Besi, Kuala Lumpur. It will reap a net gain of RM31 million, contributing 21% of our FY16 net profit forecast of RM148 million.

E&O’s calendar year 2015 price-earnings ratio of 15.7 times is at a premium to the Malaysian property sector weighted average of 12.7 times. But the price/RNAV of 0.4 times is at a sharp discount to the sector average of 0.6 times. We like E&O for the deep value of its assets and as a beneficiary of a fast-developing Penang. Key risks are slower property sales and execution risk of its STP2 project. — Affin Hwang Capital, July 13

This article first appeared in The Edge Financial Daily, on July 15, 2015.