Investment Highlights

• We downgrade our sector recommendation to UNDERWEIGHT from NEUTRAL. We hold the view that the current slowdown in the local construction industry sector is no ordinary sector cyclical downturn, but a secular change to the sector’s fundamentals. This change is largely triggered by:
  1. The new administration’s move towards fiscal sustainability, which translates to reduced spending on public infrastructure projects. To recap, the government in Budget 2019 sets itself national fiscal deficit targets of 3.4%, 3.0% and 2.8% of GDP in 2019-2021, from a peak of 3.7% in 2018. Also, during the recent Mid-Term Review of the 11th Malaysia Plan, the government has cut the development expenditure allocation for the 5-year plan by RM40bil to RM220bil from RM260bil, as compared with RM268bil spent during the 10th Malaysia Plan; and 2. The emergence of a two-party political system in Malaysia following the recent 14th general election (GE14). This enhances the checks and balances within the system of government, particularly the public procurement system. With a strict adherence to open bidding in the award of government contracts (under a tight scrutiny by the opposition and the media), we envisage a “new normal” for construction margins which will be, at best, only half of what they used to be.
• Over the next 12 months, we expect public projects that are to be rolled out to largely comprise smaller scale/value-formoney basic infrastructure projects such as road upgrading, bridges, schools, drainage, rural water and electricity supply and smallish sewerage schemes. The only segment that may see the rollout of larger work packages is the rail sector by virtue of the RM2.46bil allocation under Budget 2019 for the upgrading of rail tracks, including Phase 2 of the Klang Valley Double Track (KVDT) project. The KVDT project entails the rehabilitation of 42km of tracks between Rawang and Salak Selatan as well as Sentul and Simpang Batu (Exhibit 2).
• Staring at the prospect of their local order book potentially falling off the cliff over the 18-24 months, local contractors have started exploring opportunities outside of their home turf (albeit riskier vs. local contracts). For instance, local piling specialist Pintaras Jaya recently acquired a piling company in Singapore while Gamuda participated in the tender for work packages of the Circle Line 6 (MRT) and North-South Corridor (expressway) also in Singapore. Meanwhile, Sunway Construction visited India to “rekindle the past relationships” with some of its former construction JV partners in India. It sees opportunities in infrastructure projects in India such as highways, metros as well as high-speed rails.

• We now value construction stocks purely based on P/E. We value large- and mid-cap construction stocks (>RM2bil in market capitalisation) at a 10x forward P/E multiple while small-cap construction stocks (

• Amidst the heightened earnings risk from construction and building material (due to the downsizing of existing public projects and the cutback on new ones), property (due to the prolonged sector slowdown) and infrastructure (due to the potential expropriation or some form of restructuring), we believe that the market will derive greater comfort by valuing construction stocks based on their near-term earnings potential, i.e. P/E. This compares with the previous “sum-of-parts” method – a combination of P/E, RNAV and DCF – which accords more generous valuations to long-term assets such as landbank and concessions that may not be immediately realisable or may no longer be realisable under the current environment.

• We may upgrade our UNDERWEIGHT call on the sector to NEUTRAL/OVERWEIGHT if the government decides to pumpprime the economy with public projects in the event of external shocks such as an unexpected slump in the global economy.

• We do not have any top pick for the sector. We have UNDERWEIGHT recommendation for all construction stocks under our coverage (Exhibit 1).

Source: AmInvest Research - 7 Dec 2018