8 December 2016

Sabah: “Land below the wind” Sector Update We made a working visit to ’s capital (KK) recently. Key findings: infrastructure development is accelerating, tourist arrivals are seeing sustained growth, oil and gas investments Infrastructure/ continue despite weak prices, and new large-scale integrated property development projects should transform Greater KK in the Property long run. Our top construction/property stock picks for exposure to Sabah’s rapid development are Gabungan AQRS (GAQRS) and WCT. Other non-rated beneficiaries could be Suria Capital and SBC Corp. Overweight (maintain)/ Overweight (maintain) Infrastructure development to improve connectivity One of the key focuses for the development of Sabah under the 11th Plan 2016-2020 (11MP) is improving connectivity via infrastructure development. Planned projects include the RM12.8bn Pan Borneo Highway (Sabah section) (PBH) and the new RM311m KK Bus Absolute Performance (%) Rapid Transit (BRT). For the long-term development of the Sabah Development Corridor (SDC), there are plans to build a new KK , 1M 3M 12M GAQRS (2.2) (12.0) 4.1 Light Rail Transit (LRT) system in KK, upgrade Airport, and WCT Hldgs (2.2) 9.9 20.4 build new railway lines to connect the north and east coasts of Sabah. Suria Cap (2.9) (0.5) (21.3) SBC Corp (5.7) (11.2) 12.1 Pan Borneo Highway – a boon for construction Borneo Highway PDP Sdn Bhd, a Warisan Tarang-UEM Group-MMC Corp joint venture (60:20:20 shareholding), was appointed as the project Relative Performance (%)

AQRS WCT Suria SBC Corp delivery partner (PDP) for the PBH Sabah project in April 2016. Three % packages have been awarded and the remaining packages are targeted to 350 be awarded by end-2017 to ensure the project is completed by March 300

2021. Potential beneficiaries are the Suria-GAQRS joint venture (JV) and 250 WCT, which are bidding for the PBH Sabah project. 200 150

Major property development projects planned 100

A major development taking place is the redevelopment of KK Port with an 50

estimated gross development value (GDV) of over RM5bn comprising One

Jul-13 Jul-14 Jul-15 Jul-16

Jan-13 Jan-14 Jan-15 Jan-16

Mar-13 Mar-14 Mar-15 Mar-16

Nov-13 Nov-14 Nov-15 Nov-16

Sep-13 Sep-14 Sep-15 Sep-16

May-13 May-14 May-15 May-16 Jesselton (developed by GAQRS-Suria JV), (developed Source: Affin Hwang, Bloomberg by SBC-Suria JV), KK Convention City (developed by Mah Sing) and Sabah International Convention Centre. Suria is also planning to acquire 28.9 acres at KK Port for about RM350m to develop an International Cruise Terminal as part of the integrated mixed development project. SP Setia is developing the RM2.2bn project in currently while the state is developing the RM4bn Tanjung Aru Eco Development. Loong Chee Wei, CFA (603) 2146 7548 Top BUYs: GAQRS, WCT for Sabah exposure; maintain sector views [email protected] We believe the rising tourist arrivals and strong demand from local and foreign buyers for waterfront properties will ensure the success of the KK Port redevelopment project. Construction contract awards for PBH Sabah should benefit the contractors with established track records and precast concrete product manufacturers in Sabah. For these reasons, our top BUYs for exposure to Sabah are GAQRS and WCT. Maintain ratings, TPs.

Valuations of companies in our universe with Sabah exposure

Stock Bbg Rating Price TP Upside Mkt Cap Core PE (x) Core EPS Gr (%) PBV (x) DY (%) ROE (%) (RM) (RM) (%) (RMbn) CY16E CY17E CY16E CY17E CY16E FY16E FY16E Gabungan AQRS AQRS MK BUY 0.88 1.24 40.9 0.3 19.6 11.6 (600.0) 68.9 0.9 - 5.6 Gamuda GAM MK BUY 4.69 5.74 22.4 11.4 19.7 17.3 (8.7) 13.9 2.9 2.6 9.6 IJM Corp IJM MK BUY 3.28 3.57 8.8 11.8 22.1 20.4 0.4 8.3 3.2 3.0 6.2 WCT Holdings WCTHG MK BUY 1.77 2.13 20.3 2.2 21.1 14.9 (56.2) 41.7 1.8 3.4 3.7 SP Setia SPSB MK HOLD 3.42 3.25 (5.0) 9.8 14.6 14.3 (12.4) 2.6 2.8 4.1 8.6

Note: Share prices as of close on 6 December 2016. Source: Affin Hwang estimates, Bloomberg Affin Hwang Investment Bank Bhd (14389-U) Page 1 of 14

8 December 2016

Infrastructure development to improve connectivity We met up with the Sabah Economic Development and Investment Authority (SEDIA) to get an update on the government’s initiatives under SDC. Under the 11MP, the government will focus on improving connectivity and logistics in Sabah as a critical factor required for the economic development of the state. The under-developed road and railway infrastructure in Sabah creates a bottleneck for economic development.

Sabah has the following competitive advantages:

 Excellent location – accessible by air from 13 global destinations;  Natural resources – rich in oil and gas, fertile agriculture land, palm oil and forestry;  Cultural heritage – third largest population in Malaysia with 32 ethnic groups spawning diverse cultural backgrounds; and  Biodiversity – rich marine life, plant diversity and wildlife habitat. World Heritage Sites in Sabah are Mount Kinabalu, Maliau Basin, Danum Valley and Imbak Canyon. Sipadan island is one of the world’s best diving sites.

Under the SDC, these competitive advantages are to be exploited for the development of the tourism, oil and gas (O&G), energy, palm oil, manufacturing and logistics, agriculture and education sectors.

Fig 1: Sabah Development Corridor

Source: SEDIA

Sabah was the sixth-highest GDP contributor to Malaysia in 2015 at 6.6% of the country’s GDP. However, it ranked 13th in terms of GDP per capita at RM19.7k in 2015, below the country’s average of RM37.1k. The state achieved stronger real GDP growth of 6.1% compared to the national average of 5% in 2015 for the first time in the past six years.

Affin Hwang Investment Bank Bhd (14389-U)

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Fig 2: Percentage share of GDP by state in 2015

Source: Malaysian Department of Statistics

Fig 3: GDP per capita by state in 2015

Source: Malaysian Department of Statistics

Fig 4: GDP growth rate for Sabah and Malaysia (at 2010 prices)

Source: Malaysian Department of Statistics

Services sector remained the highest contributor to Sabah’s GDP at 40.8% of the total, followed by the agriculture sector (21.8% of total) and the mining and quarrying sector (25.4% of total) in 2015. Since the SDC was launched in 2008, the state has achieved committed investments of RM157bn and realised investments of RM57bn. We understand that and other multinational oil companies are the largest investors in the state to develop new deep water oil and gas fields in Sabah.

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Fig 5: Sabah’s GDP breakdown in 2014 and 2015

Source: Malaysian Department of Statistics

Sabah is the top crude palm oil (CPO) producing state in Malaysia with the highest oil extraction rate. Sabah produced 29% of Malaysia’s total CPO production in the first 10 months of 2016. It is also the largest aquaculture and seaweed producer in Malaysia. Tourism is a key driver of the services sector GDP growth in Sabah with tourist arrivals achieving a CAGR of 9% in 2002-2015. The state has the largest crude oil reserves in Malaysia at 45% of the country’s total reserves of 4bn barrels. The state’s crude oil reserves have increased in recent years with the discovery of new deep water reserves off the coast of Sabah.

Fig 6: Crude palm oil production by state in January-October 2016

Source: Malaysian Palm Oil Board

Affin Hwang Investment Bank Bhd (14389-U)

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8 December 2016

Fig 6: Tourist arrivals to Sabah (2002-2015)

Source:

Fig 7: Malaysia’s oil and gas reserves breakdown

Source: SEDIA

One of the key focuses for the development of Sabah under the 11th Malaysia Plan 2016-2020 (11MP) is to invest in infrastructure to improve connectivity within the state and international linkages. Some of the planned infrastructure projects include the RM12.8bn PBH Sabah and new RM311m KK BRT. For the long-term development the Sabah Development Corridor (SDC), there are plans to build a new KK Airport, Light Rail Transit (LRT) system in KK, upgrade , and build new railway lines to connect the north and east coasts of Sabah.

WCT is one of the Peninsular Malaysia-based contractors that has been active in undertaking infrastructure and property projects in Sabah. It undertook the RM704m upgrading and expansion works for the Kota Kinabalu International Airport Package 1 – Terminal Building and Landslide Infrastructure & Facilities and the RM109m Kudat Water Supply Scheme – Milau Dam project previously. WCT received a Letter of Intent from the government for the Kota Kinabalu Water Supply Scheme project worth about RM2.8bn previously but the implementation has stalled.

Affin Hwang Investment Bank Bhd (14389-U)

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8 December 2016

Fig 8: Transportation proposal map in Sabah Structure Plan 2033

Source: SEDIA

Pan Borneo Highway – a boon for construction The PBH Sabah is a 706-km highway stretching from Sindumin to Kudat in the north and Tawau to the southeast. The highway will also link to Brunei and with a total distance of 1,236 km. The highway would improve the connectivity of major towns and cities in and is expected to attract more domestic and foreign direct investment in Sabah and Sarawak to spur economic growth in the long run.

The PBH Sabah project has been divided into 35 packages worth RM350- 400m per package. Three packages have been awarded to local Sabah contractors and the intention is to award all remaining packages to local contractors. But contractors from Sarawak and Peninsular Malaysia may be allowed participate through joint ventures if there are insufficient local players with the expertise to undertake all the remaining packages. We understand that the Suria-GAQRS joint venture (JV) and WCT are interested in bidding for the PBH Sabah project.

Affin Hwang Investment Bank Bhd (14389-U)

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8 December 2016

Fig 9: Pan Borneo Highway Sabah alignment

Source: Knight Frank

Gabungan AQRS is a potential beneficiary as it plans to bid for the PBH Sabah project together with Suria Capital. Meanwhile, it is expanding the precast concrete plant under its 49%-owned Sedco Precast Sdn Bhd, a joint venture with state-owned Sabah Development Corp, to supply precast concrete products for the PBH Sabah project. Since there are local content requirements for the sourcing of precast products, Sedco Precast should benefit given it owns one of the largest precast concrete plants in Sabah.

Major property development projects planned

The Sabah property market was hit by weak sentiment this year due to the tight lending policy imposed by the banks and affordability issues. The higher cost of living following the implement of the Goods and Services Tax (GST) contributed to the property market downturn. The residential property market was hit by a slowdown in transaction volume since 1H15, hitting a low of 1,667 units (-36% yoy) in 1H16. Transaction value fell to RM559m (-33% yoy) in 1H16 after hitting a peak of RM832m in 1H15.

Fig 10: Residential property transaction volume and value in Sabah

Source: NAPIC

Affin Hwang Investment Bank Bhd (14389-U)

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8 December 2016

According to Knight Frank, the office market remained robust in KK with the average occupancy rate remaining high at 91.8% and average rental rates hitting a record high of RM2.71 psf in 2015. However, the surge in net retail space to 5.65m sq ft (+16% yoy) with the completion of new malls led to a decline in average occupancy rates to 78% in 2015 from 91% in 2014. The IMAGO opened on 28 March 2015, which has set itself apart by being owned by a single owner compared to other malls that are partial and fully strata-titled.

There are several major property development projects being undertaken or planned in KK Port and Tanjung Aru, Sabah. The redevelopment of KK Port has a GDV of over RM5bn comprising One Jesselton (RM1.8bn GDV developed by GAQRS-Suria JV), Jesselton Quay (RM1.8bn GDV developed by SBC-Suria JV), KK Convention City (RM1.4bn GDV developed by Mah Sing) and Sabah International Convention Centre.

The Jesselton waterfront integrated mixed development would change the landscape of KK with iconic buildings with close proximity to the jetty for island hopping to popular beaches on Gaya island. Suria is also planning to acquire 28.9 acres at KK Port for about RM350m to develop an International Cruise Terminal as part of the integrated mixed development project complementing the nearby Jesselton waterfront development.

Fig 11: Kota Kinabalu Port Aerial View

Source: Suria Capital

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Fig 12:

Source: Knight Frank

Fig 13: Jesselton Quay

Source: Knight Frank

Fig 14: Kota Kinabalu Convention Centre

Source: Knight Frank

SBC Corp had a maiden launch comprising 300 units of serviced apartments for its Jesselton Quay project on 26 October 2016. All the units were booked in the first two hours of launch at selling prices of RM1,000- 1,200 psf. We gather that most of the buyers were locals. This highlights the strong inherent demand for waterfront and prime properties in KK.

Affin Hwang Investment Bank Bhd (14389-U)

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8 December 2016

SP Setia is developing the Aeropod project in Tanjung Aru with a remaining GDV of RM2.2bn. We gather that it has launched RM500m worth of properties and has achieved take-up rates of 95% to date. Serviced apartments were sold at an average selling price of RM800 psf with the latest launch at RM950 psf. The redevelopment of the train station to Danum was an integral part of the Aeropod mixed development project.

Fig 15: Aeropod @ Tanjung Aru

Source: Knight Frank

Besides SP Setia and Mah Sing, some of the other listed property developers with projects in Sabah are WCT, Gamuda and IJM Corp. But the Sabah projects only form a relatively small proportion of these large developers’ total GDV (less than 6% of total GDV). Hence, the property developers that are focused in Sabah with a large proportion of their total GDV in Sabah are GAQRS (57% of total GDV) and SBC Corp (38% of total GDV).

Fig 16: GDV of Sabah projects for selected developers

Source: Company

Affin Hwang Investment Bank Bhd (14389-U)

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8 December 2016

Fig 17: Sabah projects’ GDV as a percentage of total GDV

Source: Company

Top BUYs are GAQRS and WCT for Sabah exposure We believe the rapid pace of development in Sabah will spur stronger economic growth in the long run. Although the infrastructure projects are mostly reserved for local Sabah contractors, we believe there will likely be capacity constraints faced by them given the large size and scope of the contract packages. Hence, we believe Peninsular Malaysia-based contractors such as GAQRS and WCT could bid for the packages by forming joint ventures with local players. We believe the JV between GAQRS and Suria to bid for the PBH Sabah project has a good chance of winning a package, given that Suria is a majority state-owned listed enterprise. Hence, these are our top BUYs for exposure to Sabah.

We maintain our Overweight sector views on Infrastructure and Property. In addition to GAQRS and WCT, we maintain BUY ratings on Gamuda and IJM, and we maintain our Hold rating on SP Setia. TPs maintained.

Key risks to our views Key risks to our positive view on the Infrastructure sector are: (1) delays in the implementation of planned infrastructure projects; and (2) rise in building material prices that will erode profit margins on some secured projects.

Key risks to our positive view on the Property sector are: (1) prolonged weak property market sentiment; and (2) potential oversupply of residential and commercial properties if take-up rates are low for new launches.

Affin Hwang Investment Bank Bhd (14389-U)

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8 December 2016

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This publication is prepared by Affin Hwang Investment Bank Berhad (“Affin Hwang”) and reviewed by Daiwa Securities Group Inc. and/or its non-U.S. affiliates (collectively, “Daiwa”), and is distributed and/or originated from outside Malaysia by Daiwa Securities Group Inc. and/or its non-U.S. affiliates, except to the extent expressly provided herein. The role of Daiwa Securities Group Inc. and/or its non-U.S. affiliates in connection with this publication is solely limited to the review and distribution of this publication ; and Daiwa Securities Group Inc. and/or its non-U.S. affiliates are not involved in the preparation of this publication in any other way. This research is for Daiwa clients only and the publication and the contents hereof are intended for information purposes only, and may be subject to change without further notice. Other than disclosures relating to Daiwa, this research is based on current public information that Affin Hwang and Daiwa consider reliable, but we do not represent it is accurate or complete, and it should not be relied on as such.

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Research Analyst Certification For updates on “Research Analyst Certification” and “Rating System” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. The views about any and all of the subject securities and issuers expressed in this Research Report accurately reflect the personal views of the research analyst(s) primarily responsible for this report (or the views of the firm producing the report if no individual analysts[s] is named on the report); and no part of the compensation of such analyst(s) (or no part of the compensation of the firm if no individual analyst[s)] is named on the report) was, is, or will be directly or indirectly related to the specific recommendations or views contained in this Research Report. For stocks and sectors in Malaysia covered by Affin Hwang, the following rating system is in effect: Stocks: BUY: Total return is expected to exceed +10% over a 12-month period HOLD: Total return is expected to be between -5% and +10% over a 12-month period Affin Hwang Investment Bank Bhd (14389-U)

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SELL: Total return is expected to be below -5% over a 12-month period NOT RATED: Affin Hwang Investment Bank Berhad does not provide research coverage or rating for this company. Report is intended as information only and not as a recommendation Sectors: OVERWEIGHT: Industry, as defined by the analyst’s coverage universe, is expected to outperform the KLCI benchmark over the next 12 months NEUTRAL: Industry, as defined by the analyst’s coverage universe, is expected to perform inline with the KLCI benchmark over the next 12 months UNDERWEIGHT: Industry, as defined by the analyst’s coverage universe is expected to under-perform the KLCI benchmark over the next 12 months

Conflict of Interest Disclosure Ownership of Securities For “Ownership of Securities” information, please visit BlueMatrix disclosure Link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. Investment Banking Relationships For “Investment Banking Relationship”, please visit BlueMatrix disclosure Link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. Relevant Relationships Affin Hwang may from time to time have an individual employed by or associated with it serves as an officer of any of the companies under its research coverage. Affin Hwang market making Affin Hwang may from time to time make a market in securities covered by this research. Additional information may be available upon request. Japan - additional notification items pursuant to Article 37 of the Financial Instruments and Exchange Law (This Notification is only applicable where report is distributed by Daiwa Securities Co. Ltd.)

If you decide to enter into a business arrangement with us based on the information described in materials presented along with this document, we ask you to pay close attention to the following items.  In addition to the purchase price of a financial instrument, we will collect a trading commission* for each transaction as agreed beforehand with you. Since commissions may be included in the purchase price or may not be charged for certain transactions, we recommend that you confirm the commission for each transaction.  In some cases, we may also charge a maximum of ¥ 2 million (including tax) per year as a standing proxy fee for our deposit of your securities, if you are a non-resident of Japan.  For derivative and margin transactions etc., we may require collateral or margin requirements in accordance with an agreement made beforehand with you. Ordinarily in such cases, the amount of the transaction will be in excess of the required collateral or margin requirements.  There is a risk that you will incur losses on your transactions due to changes in the market price of financial instruments based on fluctuations in interest rates, exchange rates, stock prices, real estate prices, commodity prices, and others. In addition, depending on the content of the transaction, the loss could exceed the amount of the collateral or margin requirements.  There may be a difference between bid price etc. and ask price etc. of OTC derivatives handled by us.  Before engaging in any trading, please thoroughly confirm accounting and tax treatments regarding your trading in financial instruments with such experts as certified public accountants. *The amount of the trading commission cannot be stated here in advance because it will be determined between our company and you based on current market conditions and the content of each transaction etc.

When making an actual transaction, please be sure to carefully read the materials presented to you prior to the execution of agreement, and to take responsibility for your own decisions regarding the signing of the agreement with us.

Corporate Name: Daiwa Securities Co. Ltd. Financial instruments firm: chief of Kanto Local Finance Bureau (Kin- sho) No.108 Memberships: Japan Securities Dealers Association, The Financial Futures Association of Japan Japan Investment Advisers Association Type II Financial Instruments Firms Association

Affin Hwang Investment Bank Bhd (14389-U)

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