ECM Libra Investment Research has downgraded MUHIBBAH ENGINEERING (M) BHD [ registerQuotes("MUHIBAH", "MUHIBAH_span"); ] to a sell at RM1.33 with a target price of RM1.11, due to company-specific issues — cost overrun, project implementation hiccups and potential funding issue due to its high leverage.

The research house said Muhibbah’s second-quarter (2QFY09) CONSTRUCTION [ registerQuotes("CONSTRUCTION", "CONSTRUCTION_span"); ] margin contracted to 1.7% due to further cost overrun from the Yemen LNG jetty project.

“Asia Petroleum Hub (APH) and South Klang Valley Expressway (SKVE) are another two projects with implementation hiccups. Work progress of APH has slowed down significantly following the pullout by the financier of the project owner, which resulted in uncollected receivable in excess of RM200 million,” it said.

ECM Libra said that removing these projects would see Muhibbah’s current order book of RM3.8 billion being slashed by 30%.

The research house also said the company’s high gearing has been a concern, especially when its profit margin has been thin.

“We carried out an ROE DuPont analysis, which revealed that much of Muhibbah’s return on its equity, depend largely on the use of leverage vis-à-vis its peers. Muhibbah has the lowest net profit margin but the highest equity multiplier.

“It also faces funding risk as it has relied heavily on short-term financing (86.8%) for its working capital as well as to finance its capex over the last few years.”

ECM Libra cut its FY09 and FY10 earnings forecast for Muhibbah by 20.6% and 26.5% respectively, to mainly account for losses from the Yemen project and implementation hiccups from APH and SKVE.

There was still further downside risk if APH’s debt turns bad as FY09 earnings per share (EPS) may fall by 194.6% into the red while net tangible asset (NTA) per share will fall by 30.1% to 86 sen.

The research house said that while some may argue Muhibbah’s current undemanding price to earnings (P/E) of 7.7 times meant that all these negative factors have already been priced in, it begged to differ.

“Due to its exceptionally high leverage, we prefer to compare Muhibbah’s valuation with its peers using EV/Ebitda. At 9.7 times based on FY10 earnings, it is more expensive than small-cap average of 5.3 times and just slightly below big-cap average of 11.1 times,” it said.

Muhibbah closed at RM1.34 last Friday, up one sen.

“Pegging a nine-times multiple based on our implied EV/Ebitda valuation for a comparable small-cap construction stock, we derive our revised target price of RM1.11 (previously RM1.77),” it said.

Muhibbah closed at RM1.34 last Friday, up one sen.