EUR 6.84 For Business Accounts Only

JKSB Corporate Update_Access Engineering PLC (AEL)_January 2017

Executive Summary

Growing order book on the back of a resumption of government-led infrastructure projects

We recommend that investors increase equity portfolio exposure to the construction sector to capitalise on positive sentiment arising from the recent resumption in public infrastructure spend. Between the two listed construction companies, AEL offers 1) better liquidity; and 2) more attractive valuations and dividend yield, and serves as an ideal proxy to the sector for equity investors given 1) an estimated 12%-15% share of work distributed among the top 7-8 local construction companies; 2) well established long standing working relationships with a majority of the international principal contractors currently operating in SL; and 3) the highest accreditation among major contractors in specialized sectors. AEL’s confirmed order book has increased by >30% over FY16-3QFY17, with ~Rs. 40bn revenue recognition remaining as at end Nov 2016, while net margins for its core construction business stand at a healthy 19% for 1HFY17 (vs. a ~12% margin for peers). We expect AEL to record double digit order book growth over the next 2-5 years, given significant pipeline opportunities on upcoming projects such as 1) stages 3 and 4 of the Central Expressway (subcontracting for Japanese and Chinese principals); 2) five proposed elevated highways; 3) the planned Kelaniya suspension bridge; 4) the BIA terminal expansion; 5) high margin water/irrigation sector work, particularly in the Polonnaruwa district; 6) PPP housing projects; and 7) overseas flyovers & expressways.

Construction materials sales +70% YoY in 1H; new capacity coming on-stream to meet demand

AEL has reported a 70% YoY increase from the sale of construction related materials in 1HFY17, supported by ongoing strong demand for concrete from large leisure and property development projects including ITC Colombo One, Access Towers 2, Altair, Blue Ocean, and AVIC’s Astoria apartment project, coupled with increasing asphalt sales supported by the recommencement of road development projects. The business tends to offer healthy margins of >20% and requires no cash/working capital due to short billing cycles. With its existing production plants running at full capacity, AEL has commissioned a new concrete plant (expected to be operational in 4QFY17) - which should add about 40% new capacity - and is also planning for further capacity additions over FY18-FY19 to meet rapidly growing demand.

Deserves to trade at a FY17E P/E of 11.0x; planned longer term increase in dividend payout

We have revised our full year earnings projection up to Rs. 2.7bn (+11% YoY) for FY17, given an expected tax write back for 1HFY17. Our revenue projections for the core construction business over FY17E-FY18E are based solely on AEL’s confirmed order book, implying healthy topline and earnings upside in the event of award of the above mentioned pipeline projects. At its current price of Rs. 24.80, AEL trades at a FY17E P/E of 9.0x, at a 9% discount to the market. We believe the stock deserves to trade at a FY17E P/E of 11x - at the mid end of its historical trading range - which is backed up by expected double digit YoY earnings growth over the next 5 years (with the exception of FY18E due to the YoY impact on post tax earnings of an increase in the tax rate to 28%). Consequently, we recommend AEL as a LONG TERM BUY at its current price of Rs. 24.80 and suggest profit taking at Rs. 30.00, which - coupled with an anticipated Rs. 1.00 full year dividend per share - translates to total shareholder return of ~25% over 12-18 months. Management intends to increase the company’s dividend payout to 50% - 60% of profit over the longer term, supported by increased tax benefits from investments in BOI projects such as Blue Star Constructions and Access Towers 2, which have tax holidays of 8 years and 12 years respectively. Key downside risk: delays in start-up of confirmed projects.