Investment Highlights

• We upgrade our weighting for the construction sector to NEUTRAL from UNDERWEIGHT following news reports over the weekend, quoting Transport Minister Datuk Seri Dr Wee Ka Siong that the government, in a recent cabinet meeting, decided to go ahead with the MRT3 project. The implementing agency Mass Rapid Transit Corporation has been given three months to update the studies on the project, including its cost and the construction will begin in 2H2021.

• Given a news flow-driven, liquidity-fuelled and risk-on stock market, we believe investors are likely to react positively to the minister’s statement. We nonetheless have reservations as follows:

1. The local political landscape remains dynamic, with a strong likelihood of the 15th general election being called immediately after the lifting of the nationwide state of emergency on 1 Aug 2021;

2. Given the government’s fiscal constraints, the implementation model of the project may gravitate towards a public private partnership of which the main contractor may be required to take on certain operating/commercial risk and/or participate in the funding of the project (East Coast Rail Link and Island A of the Penang Transport Master Plan are good examples); and

3. The construction period may be prolonged to lighten the stress on the government’s cash flow that means the earnings impact of the MRT3 project on construction companies may not be as significant as compared with the MRT1 and MRT2 (that were fast tracked).

• To reflect the improved trading sentiment towards construction stocks on the back of the latest news, we raise our benchmark forward target PE for large- and mid-cap contractors to 14x from 12x (except for Gamuda to 13x from 11x to reflect its riskier order book with self-funded reclamation works for Island A of the Penang Transport Master Plan) and for small-cap contractors to 9x from 8x.

• As a result, we raise the fair values (FV) of construction stocks under our coverage by 6–17% (Exhibit 1). We upgrade Sunway Construction to HOLD from UNDERWEIGHT, while maintaining HOLD for Gamuda, Hock Seng Lee and Kimlun Corp and UNDERWEIGHT for IJM Corp and Econpile.
   
• The minister’s statement on the MRT3 project aside, the fact remains that the government will have very limited room for fiscal manoeuvre given the elevated national debt, weighed down further by the economic impact of the pandemic (including reduced tax and petroleum revenues), as well as the massive relief spending to cushion the economic impact of the pandemic.
   
• Operationally, construction players are subject to higher operating cost and lower efficiency (due to restrictions on working hours and worker density on the site, and the additional expenses incurred in upgrading the dormitory for foreign workers in compliance with the Worker’ Minimum Standards of Housing and Amenities Act 1990, also known as Act 446) and higher operating risk (due to the potential stop-work order or enhanced movement control order on the dormitory in the event of Covid-19 infection and, shortage of foreign workers as borders remain largely closed).

• Amidst the uncertainty in the rollout of public infrastructure projects locally, a number of players have ventured into or returned to overseas markets. For instance, Sunway Construction in 2020 bagged two highway projects worth more than RM800mil in India on a hybrid annuity model, while Econpile secured a US$85.7mil (RM347.6mil) piling and substructure works in Phnom Penh, Cambodia. Meanwhile, Gamuda has been shortlisted for three motorway/metro line projects (that require extensive tunnelling works) in Australia.

• We do not have any top pick for the sector. However, for the purpose of anchoring a portfolio, we recommend Gamuda (HOLD; FV RM3.49) and Sunway Construction (HOLD; FV RM1.80).

Source: AmInvest Research - 5 Apr 2021