E&O’s deep value rises on share price decline

The potential crystallisation of Seri Tanjung Pinang Phase 2’s (STP2) value with its plan to secure a strategic partner in the next six months is a key catalyst. We upgrade our call on E&O to “buy”.

We cut E&O’s financial year ending March 30, 2016 forecast (FY16F) and FY17F normalised earnings by 73% and 52% respectively to RM32 million and RM45 million, and introduce FY18F earnings of RM60 million. We have mainly imputed slower-than-expected progress billings and delays in project launches. 

While E&O’s unbilled sales stand at about RM908 million (as at the first quarter of FY16), we understand that the bulk of it is from Tamarind Phase 1 and The Mews, which are still in early stages of construction.

The key projects that we expect to drive sales from FY16F to FY18F are Tamarind (gross development value [GDV] of RM900 million), Conlay (GDV of about RM800 million), Avira Phase 2 (GDV of about RM100 million) and further sales of its last Andaman tower.

While the near-term outlook remains challenging with E&O’s exposure to the high-end segment, the long-awaited award of Phase 2A of STP2 to China Communications Construction Co Ltd, for the reclamation of 253 acres (102.39ha) of land and 131-acre extension of Gurney Drive for RM1.035 billion on Oct 28, marks a milestone. Reclamation work should commence in the fourth quarter of 2015 and will take 30 months to complete.

E&O’s immediate plan is to secure a long-term strategic partner to invest up to a 49% stake in Phase 2A in the next six months, which should help crystallise the value of STP2 and reduce its funding requirements. 

With a potential GDV of RM25 billion over 15 years, we estimate that STP2 could generate RM700 million in sales per annum, contributing about RM83 million in earnings per annum, assuming a 20% profit-before-tax margin and E&O’s 79% stake. We have not included this in our forecasts, as the earliest launch will likely be in 2018. 

The stock has fallen 31% over the past 12 months, underperforming the Kuala Lumpur property index and FBM KLCI, which declined 15% and 9% respectively, due to poor earnings delivery and the euphoria over STP2 subsiding. 

While we still value the company largely on a revised net asset value (RNAV) basis, we now ascribe 10 times price-earnings ratio to its average FY16F to FY18F property development earnings to adequately capture its lack of earnings visibility. 

We have applied a 50% discount to STP2’s net value and a 20% discount to overall RNAV to derive our new TP of RM1.80. Even with such conservative valuations, there is a 15% potential upside.

This article first appeared in The Edge Financial Daily, on November 23, 2015. Tap here to subscribe for your personal copy.