Performance of sector earnings, as of 1QFY23, was below our expectation. Most companies under our coverage, except for Gamuda and MGB, reported lower construction earnings during the quarter. The sector is still beleaguered by elevated construction cost and depleting orderbook, against the backdrop of a more intense playing field as competition rises. Post-pandemic, the number of licensed G7 contractors grew almost two-fold in as of 2021, though falling slightly in 2022. We favour Gamuda and IJM Corporation as both companies possess niche engineering and specialised capabilities which would enable them to provide distinct offerings in comparison to their peers with only general capabilities. That said, we expect construction margin growth to be flattish, in between 6%-8% on average at pretax (PBT) level moving forward, pressured by still-elevated construction cost. Going into 2H2023, we expect the sector will gain traction from increased news flow, in addition to the rollout of mega infrastructure and sizeable development projects i.e.: MRT3, Bayan Lepas LRT, Penang South Islands (PSI) Island A, Subang & Penang airport expansion as well as numerous public projects allocated in Budget 2023.

• High-impact work lacking. Value of work done, albeit registering higher growth from the previous year, is still below pre-pandemic levels. The value of projects awarded year-to-date (announced on Bursa) has slumped >20% YoY meanwhile. Overall sector activity is still soft as high impact project rollouts are noticeably lacking, with listed contractors not required to announce transaction of <5% of net assets.

• Heated playing field. While the sector no longer faces issues on foreign labour, we opine that the real hurdle commences at this juncture – declining orderbook due to improved work efficiency, prompting contractors to compete for projects in order to replenish their respective construction orderbook. Current orderbook for the top 24 KL Construction Index (KLCON) component members provide earnings visibility for about 2 years on average.

• Maintain Overweight. We believe the sector earnings will perform better in the coming quarters as construction costs have stabilised, in addition to increased work efficiencies. Besides, progress billings from newer projects will help in keeping margins afloat as newer projects tend to fetch better margins compared to old ones. Overall, sector headwinds such as volatile building materials prices and labour shortage have dissipated. Above all, we are optimistic on the sector’s turnaround going into 2H2023, supported by the rollout of mega infrastructure and sizeable development projects as well as numerous public projects allocated in Budget 2023

Source: PublicInvest Research - 30 Jun 2023