Kenanga Research & Investment

Author: kiasutrader   |   Latest post: Wed, 2 Dec 2020, 9:11 AM


Construction - Unjustifiably Cheap

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We maintain our Overweight call for the sector as we feel the timing is now prime to accumulate construction counters prior to key events such as Budget 2021 and 12th Malaysian Plan. Current KLCON valuations of 11.5x FY21E PER which is close to GFC lows (of c.10x) is unjustifiably low given that the sector is on the cusp of a recovery, backed by potential projects such as RTS, MRT3 and possibly HSR. While there might be some lingering concerns over a snap general election and the government’s limited fiscal strength, we believe the situation is not as bad as feared. A snap election could lead to political stability while there are a number of funding options the government can tap into. Our top picks for the sector are Gamuda, Suncon, Kimlun and Kerjaya.

Total contracts awarded to KLCON contractors still encouraging despite the unprecedented Covid-19 crisis. As of 9MCY20, contractors within KLCON universe have clinched a total contract value of RM9.8b (based on their Bursa announcements), 8.4% lower YoY compared against 9MCY19 contract value of RM10.7b. While FY20 is likely to end the year on a weak note (i.e. weakest in 5 years since 2014), our view is that FY21 contract awards will rebound and continue to grow for the subsequent years underpinned by growth projects such as MRT3, Sabah Sarawak Link Road, Pan Borneo Sabah, RTS, Bandar Malaysia and possibly HSR.

Tenders in the pipeline to materialise in FY21. Channel checks indicate that sentiment on the ground is gradually picking up. Post 2QCY20 results season, contractors are more optimistic (as compared to post 1QCY20 results season) and generally expect more jobs to be rolled out as the Covid-19 situation has been relatively well controlled. Among jobs that could potentially fuel awards in the near future include new hospitals, and ECRL, Also, being more familiar with the Covid-19 SOP guidelines, contractors within our coverage have indicated that operating levels have recovered significantly to 60%-100% currently vs 20%- 40% during MCO and CMCO.

ECRL awards have been small in quantum and only benefitting the small-mid caps listed players so far. To recap, CCCC has promised to dish out c.RM10b of works to local contractors i.e. 40% of civil works only and not 40% of the entire RM44b project. As expected, the ECRL awards thus far has been piecemeal and trade-specific in nature. The larger contractor’s wish of having a vertically cut portion carved out has yet to be seen. That said, in our recent engagement with IJM, they remain optimistic in securing a vertically cut package – especially when ECRL runs right through their 60%-owned Kuantan Port.

Consensus agree that MRT3 should be revived, but are doubtful on HSR. Concerns surrounding the resurrection of HSR includes the massive government funding required and the lack of commercial viability of the project. Based on our back of the envelope calculations (refer table below), at best, the existing ridership’s revenue can only cover slightly more than half of the financing cost if the HSR is priced at RM68b (latest quoted figure). Hence, we think a RM68b price tag is excessive and should be lowered for viability. However, we note that our analysis is purely on a commercial perspective at the business level and do not incorporate synergistic elements at the national level i.e. higher demand for homes along the HSR stretch, enhanced tourism and increased business activities and diplomatic ties between two nations.

Construction sector share prices have been lacklustre, mainly due to two factors we gather: (i) worries of a snap election, and (ii) government’s weak fiscal position to dish out contracts. In terms of a snap election, we are of the view that should it be held, this would mean that the existing coalition is confident of winning. Counter-intuitively, a snap election in this manner could actually be good for the construction sector as political stability would be achieved. Funding-wise, we believe the government has more capacity to spend than what consensus think. Among the options we can think of are: (i) more dividends from Petronas, (ii) monetise Petronas through a private stake sale to GLCs, (iii) more dividends from Khazanah through asset/equity sales, and (iv) increasing debt-to-GDP ceiling further to 65%.

Unjustifiably low trading valuation. As of 25th Sep 2020, the KLCON Index (of 156.7) is trading at FY21E PER of 11.5x, -1SD below its 10-year mean and close to GFC lows of 10x. We think the sector’s appeal to investors will gradually increase as we approach Budget-2021 (on 6th Nov 2020) and 12th Malaysian Plan (Jan 2021) in anticipation of the potential roll-out of mega infrastructure projects namely MRT3, Pan Borneo Sabah, Sabah Sarawak Link Road and potentially HSR. During this time, we do not discount the possibility for the KLCON Index to re-rate to 17x PER (or +2SD above mean) and hit 230, providing 47% upside from current levels.

Maintain OVERWEIGHT. We maintain our investment thesis that the construction sector will be a key lever the government of Malaysia can pull to accelerate an economic recovery amidst the Covid-19 crisis. This can be done via expediting existing projects and the introduction of new mega projects to keep future pipelines filled as jobs like MRT2 approaches its tail-end. Overall, construction remains a cyclical sector of which stocks’ prices rally tend to precede news flow. Therefore, with contract flows still in its infancy stages, we find it fitting to build positions into the sector now. Our top picks for big caps are GAMUDA and SUNCON whereas our small/mid-cap picks are KIMLUN and KERJAYA.

Source: Kenanga Research - 5 Oct 2020

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