Dec 22, 2014

Malaysian Construction Sector 2015 Outlook

A flurry of construction jobs to keep contractors’ earnings visible   ..POSITIVE

Construction gdp growth to remain robust. We are positive on the Government’s GDP forecast of 10.7% for the sector in 2015. It will be the fourth consecutive year of double-digit growth for the sector. We opine that the high growth target has taken into account the work progress of various property development projects and construction works which have been awarded in the past three years.

List of Malaysia Budget 2015 projects and estimated value (rm)

• Budget 2015 offers a flurry of construction activities. The sector’s earnings prospect remains strong backed by mega highways and rail-lines development projects. We are of the view that the Government will prioritize these projects for implementation next year against the backdrop of country’s focus on fiscal tightening. Large and small-cap local construction companies will set to reap the benefits of construction job awards. It will spur construction job opportunities for companies to replenish their order book and keep their earnings visible over the next three to four years.

• Continued infrastructure investments in the 11th Malaysian Plan. As we enter into final year of 10th Malaysian Plan, we expect the Government will continue to map out its approach to upgrade physical infrastructure in the next five years. The multiplier effect from physical infrastructure projects will continue to be the catalyst to the other sectors as well as to attract domestic and foreign investments to support the country’s economic growth. This will reaffirm robustness of the construction sector.
• Decline in oil price may put a damper.
However, the recent pullback in oil price and likelihood of reduction in capex spending next year by Petronas will result in increased risk of slower contract awards to construction companies. We are of the opinion that there is possibility of a decline in Government’s revenue next year although partially offset by removal of subsidies. As such, downside risks to the sector includes: (1) scale back of government contracts, (2) delay in implementation of 10th MP projects, (3) further slowdown in residential property market due to “cooling measures” which have already been implemented by authorities, and (4) higher material costs due to the upcoming implementation of GST.
• Prices of building materials to stay low. We note that building material prices particularly steel have been declining. Price of steel bars has retraced by 43% as at end September 2014 from its respective peaks in 2011. Meanwhile, cement producers has been under pressure to hold their cement price as the industry is facing overcapacity. Thus, this environment will offer construction companies to lock-in lower construction materials cost ahead of the implementation of GST.
• Potential earnings growth may be underestimated. Valuation-wise, we are not surprised to see KLCON Index is still trading at a discount to its historical 5 years rolling 4-quarter PER of 17x. As at 21st November 2014, the KLCON Index’s blended and forward PER were trading at only 12.2x and 11.6x respectively. This implies that the market has been valuing construction companies lower amidst a slowdown in construction companies’ earnings from slower progress billings and higher risks associated with project delays. However, we do not see contract awards drying up as yet and we expect construction stocks to offer good upside potential in anticipation of the award jobs for mega projects in the coming months.

• MAINTAIN POSITIVE. Premised on above, we maintain our POSITIVE recommendation on construction sector. Our top picks for the sector are:
(i) Gamuda (TP: RM5.28) with a potential upward revision on the account of MRT Line 2, Penang transport job PDP and SPLASH’ net asset revaluation, and (ii) Protasco (TP: RM2.45).  On the other hand, construction companies particularly IJM Corp (TP: RM7.20), relisting of Sunway Construction (non-rated), Muhibbah Engineering (non-rated), Hock Seng Lee (TP:RM2.14), Mitrajaya (non-rated), Gadang (non-rated), Pintaras Jaya (non-rated), Econpile (non-rated), AZRB (non-rated) and Melati Ehsan Holdings (non-rated) are poised to be beneficiaries of jobs in the upcoming implementation of mega projects. Apart from abovementioned projects, we expect to hear more developments on other larger-scale projects such as the RM40b KL-Singapore High Speed Rail, RM26b Tun Razak Exchange, RM5b PNB Warisan Merdeka Tower, Penang Integrated Transport jobs, RAPID and power plants projects as well as the development of five Economic Corridors.