Investment Highlights

• We maintain our UNDERWEIGHT recommendation for the construction sector. We expect muted prospects for the sector in 2020 as it continues to retreat from a super-cycle fuelled by debt-funded public infrastructure projects spanning over 10 years from 2008 to 2018, which turned out to be unsustainable.

• Our view is confirmed by the surprise 25bps cut in the overnight policy rate (OPR) by Bank Negara Malaysia (BNM) last month. Acknowledging the constraints in fiscal space (due to “delays in the implementation of projects” as explicitly mentioned in BNM’s monetary policy statement dated 22 Jan 2020), the central bank is looking to rely on monetary easing to sustain economic growth. While the government may introduce a stimulus package to counter the potential drag on the economy from the prolonged Wuhan coronavirus epidemic, we believe the focus will be on small-scale shovel-ready projects such as roads, pavements, bridges, schools and public amenities (that will benefit mainly the smallish and unlisted construction outfits).

• In 2020, as far as spending on public infrastructure projects is concerned, we believe the government’s focus will be on completing ongoing projects at a reduced cost and/or over an extended construction period (to help ease strains on the government’s cash flow). These include the East Coast Rail Link (ECRL) (RM44bil), MRT2 (RM30.5bil), LRT3 (RM16.6bil) and the Pan Borneo Highway, Sarawak (RM16.5bil) (Exhibit 2).

• Given the still elevated national debt and its commitment towards fiscal prudence, we sense great reluctance and hesitation from the government to revive projects which have been put on hold, or embark on new projects, with the exception of the Johor Bahru-Singapore Rapid Transit System (JB-Singapore RTS) (RM3.6bil) and Sarawak-Sabah Link Road (RM5.2bil).

• We are more inclined to see the revival of the JB-Singapore RTS project as an isolated case (and hence, it should not be regarded as a telltale sign that the government is going all out to start new projects). Firstly, we believe a revised estimated price tag of RM3.16bil (a cheaper system, i.e. the LRT vs. MRT previously) as compared with RM4.93bil initially, is more palatable to the cost-conscious government. Secondly, Malaysia may be liable to a hefty abortive cost to be paid to Singapore if the project is delayed further or terminated.

• Meanwhile, touted as the first road that connects Sarawak and Sabah without passing through Brunei, the 425km Sarawak–Sabah Link Road appears more to be a “long-term” project which will span over a decade. Works Minister Baru Bian was quoted by the media as saying that the project is divided into two packages. The first package is expected to start in Oct 2020 and be completed in 2024, while the second one will only be ready by 2030.

• Meanwhile, Sarawak has decided that it wants to take control of its own destiny by resorting to state reserves to fund RM11bil of public infrastructure projects, including the Coastal Road, Second Trunk Road and 11 mega bridges. However, the rollout of work packages from these highly publicised projects seems to have hit a snag after the initial hype.

• On the other hand, Penang is hopeful of securing federal funding to kick-start its ambitious Penang Transport Master Plan, a RM46bil project to improve public transport (particularly, via the Bayan Lepas LRT) and road infrastructure (particularly, via the Pan Island Link). Alternatively, it may take on debt to finance the reclamation of the 790-acre Smart Industrial Park of the 2,300-acre Island A. Once completed, the industrial park will be sold, and the cash flow and profits will be ploughed back to fund the Bayan Lepas LRT, Pan Island Link and further reclamation works on Island A, as well as Island B (1,100 acres) and Island C (800 acres) (together, the three man-made islands are known as Penang South Reclamation).

• We believe valuations of construction stocks are lofty with a weighted average forward P/E of 18.9x on a weighted EPS growth rate of only 2.1% in FY20F (Exhibit 1).

• 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

Source: AmInvest Research - 6 Feb 2020