MARC has placed its rating of AA-IS on Matang Highway Sdn Bhd’s (Matang) RM70.0 million sukuk Musharakah issuance on MARCWatch Negative. The MARCWatch Negative placement highlights that Zecon has fallen behind schedule in the second phase of construction of the Matang Route Project for Jabatan Kerja Raya Sarawak (JKR Sarawak). Matang services its obligations under the rated sukuk with progress payments from the Matang Route Project. Accordingly MARC believes that the delay in construction progress would affect Matang’s liquidity position and ability to meet significant upcoming sukuk service obligations in the absence of mitigating developments.

Matang is a wholly-owned subsidiary of Zecon Berhad (Zecon), a Bursa Malaysia listed construction group, and was established as a single-purpose entity to undertake the issuance of the sukuk to provide capital contribution to Zecon. Zecon was awarded a turnkey contract by the Jabatan Kerja Raya Sarawak (JKR Sarawak) for the design and construction of the highway from Kuching City to the proposed new Federal Administrative Centre in Rambungan, Sarawak (Matang Route Project) on July 10, 2002. On August 23, 2007, the contract was revised to also include an alternative route to enter Kuching city. As a result, the construction was divided into two phases, the Original Matang Route (OMR), with a contract value of RM203.29 million and the Revised Matang Route (RMR), with a contract value of RM124.15 million.

The OMR had been granted an Extension of Time (EOT) by JKR Sarawak to May 2009 from its initial completion date of December 2008 but only 98.78% was completed as at June 25, 2009. Zecon has now applied for a further extension up to August 17, 2009 which is pending JKR Sarawak’s approval. Meanwhile, the RMR, which was scheduled to be completed in March 2011 and expected to achieve overall progress of 54.06% by December 2008 based on original projections, achieved actual progress of only 7.54% as of December 2008. As such, a new revised schedule was requested and an EOT until July 26, 2011 was granted by JKR for the RMR. Based on the revised schedule, the planned progress as of December 2008 is 8.80% and Matang needs to complete 44.95% by September 2009. As of June, 2009, Matang has achieved overall actual progress of 14.86% on the RMR. MARC views the delay in OMR completion from the original schedule and the slow construction progress on the RMR signals a substantial increase in overall project execution risk which would expose Matang to significant timing mismatches between sukuk maturities and project cash flows.

Construction receipts from the Matang Route Project are the main source of repayment for the sukuk. The progress payments are deposited into a designated account to first meet the minimum required balances build up towards principal and profit payment for the sukuk. The next minimum required balance of RM8.0 million is expected by end August 2009. Any prolonged delay in construction progress will affect Matang’s ability to maintain minimum required account balances in the Finance Service Reserve Account, Finance Service Account and Sinking Fund Account.

For the year ended December 31, 2008, total progress payments received amounted only to RM52.1 million, significantly below the projected amount of RM138.8 million. Matang recorded negative cash flow from operations (CFO) of RM5.6 million in 2008. To date, the sukuk’s Series 1 principal repayment of RM35 million which was due in May 2009 has been duly satisfied by Matang as confirmed by trustee. However, MARC is concerned as to the increased uncertainty surrounding the timing of subsequent progress payments vis-a-vis scheduled sukuk maturities of RM20.0 million and RM15.0 million in May 2010 and May 2011 respectively.

MARC expects to resolve the MARCWatch placement once greater clarity is obtained regarding actions that will be taken by Matang to mitigate the timing mismatches between sukuk maturities and project cashflows. The rating may be lowered if MARC believes that Matang’s credit profile is no longer consistent with its current rating.

Contacts:
Khairul Emran bin Mahmud 03-2090 2278 / emran@marc.com.my;
Ezien Hoo 03-2090 2267 / ezien@marc.com.my