Investment Highlights

• We maintain our UNDERWEIGHT recommendation for the construction sector on the back of: (1) the continued cutback in public infrastructure spending as the government tightens its belt; (2) the prolonged downturn in the property market with oversupply in virtually all segments comprising residential, commercial, office and retail; and (3) the deterioration in cash flow along the entire value chain due to slow payment (or non-payment) by both public and private sector clients. Already, some of these receivables problems have escalated to defaults and contract disputes.

• The Prime Minister's Office has issued a statement announcing that the East Coast Rail Link (ECRL) project has been revived via a supplementary agreement signed with China Communications Construction Company Ltd (CCCC), with the construction cost for Phases 1 & 2 for the project being reduced by RM21.5bil to RM44bil from RM65.5bil. Further details of the revised deal will be revealed during a press conference scheduled for next Monday.

• It is uncertain at this point what will be the extent of the local participation in the project (or if there is any change from 30% previously). Given the sharply reduced project cost, in order to minimise the loss of profits, we are doubtful that if the Chinese contractor will offer substantial sub-contracting works to local players, and in the event it is required to do so, if it will offer high-value jobs (such as tunnelling and construction of large bridges) to local players.

• While the revival of the ECRL is positive to both the construction and building material sectors, it is no game-changer to these industries. We estimate that the additional demands for cement and steel bars only amount to 1–2% of the current annual consumption of cement and steel bars locally.

• Also, given the government’s strong commitment to fiscal prudence, we are concerned that this could be a “zero-sum game” as the revival of the still massive ECRL may deprive the government of its ability to implement other infrastructure projects over the next 4–5 years.

• We believe the market has also very much priced in the news, given the strong run-up in share prices of construction stocks over the last 1–2 months. Also after the run-up, valuations of construction stocks have become excessive with weight average FY19-20F P/Es of 17.2x and 16.3x (Exhibit 1) which are unjustified given the muted industry outlook.

Source: AmInvest Research - 12 Apr 2019