Investment Highlights

• Mixed 1QCY22 results. Out of the 5 companies under our coverage, 1 was above expectations, 2 within and 2 below. WCT Holdings outperformed mainly due to better-than-expected earnings contribution from its property development segment. Meanwhile, Econpile Holdings recorded a loss due to high material prices and labour shortage, while Kimlun Corp swung into losses, dragged by poor sales for the manufacturing and trading segments, higher cost of raw materials and lower margins for properties sold in the quarter. IJM Corp and Sunway Construction’s (SunCon) earnings were within our expectations.

• Rising building material costs affected sector performance. Excluding WCT’s bottom line which grew significantly due to a one-off arbitration award of RM260mil booked in the preceding quarter, sector earnings fell 16% QoQ, attributed mainly to depressed margins resulting from increased cost of raw materials.

• Erosions in operating profit margins. We expect building material prices to remain elevated as the Ukraine-Russia war is taking longer than expected to resolve. According to the Ministry of International Trade and Industry (MITI), steel bar prices rose 11% to RM3,450/MT in May 2022 from RM3,100/MT in May 2021 while the Department of Statistics Malaysia (DOSM), cement price rose 10% to RM18.81/50kg in May 2022 from RM17.15/50kg in May 2021 (Exhibit 3).
  Although the variation-of-price (VOP) clause, which was reintroduced for government contracts in July 2021, allows contractors to claim cost fluctuations, most private projects do not have such provision for variation orders. While contractors would be able to incorporate the rising cost for new projects in the form of increased contract values, the higher cost would still lead to higher working capital requirements.

• Macro challenges in the sector. The government’s fiscal position has been weighed down by the economic impact of the pandemic and the massive relief spending to cushion the consequences. Furthermore, the national debt remains elevated. Hence we believe that going forward, the rollout of public infrastructure projects will most likely adopt a private funding initiative structure which would alleviate immediate capital outlay from the government. However, this would also mean that the main contractors would be required to take on higher risks to participate in the funding of projects.

• Tender process for the 3 civil work packages for the MRT3 has begun. Tender submission deadlines are 30 Aug 2022 for CMC301 and 2 Aug 2022 for CMC302 and CMC303. We estimate the contract values of CMC301 at RM2.1bil, CMC302 at RM9.7bil and CMC303 at RM14.6bil (Exhibit 4). As these packages would require minimum financing for the initial 2 years or 10% of contract value, the main beneficiaries are expected to be IJM and SunCon as they have strong balance sheets and proven track records. We expect WCT’s role to be limited to subcontracting due to the group’s stretched balance sheet. We also believe that Kimlun and Econpile would benefit from the rollout of these packages as they have won sizable jobs from the previous MRT projects. Barring any delays, we expect these packages to be awarded in 4QCY22.

• We stay NEUTRAL on the sector. In spite of the potential award of the MRT3 project which would revitalise the industry, we are cautious on the sector due to elevated building material costs and potential delays/shelving of mega projects. We would upgrade our call on the sector to OVERWEIGHT if the pressure on building material costs eases and the government decides to forge ahead with the implementation of key public infrastructure projects.

• Risks to the sector include:
  1. Rising building material costs led by an escalated or prolonged Ukraine-Russia war;
  2. Delays or shelving of mega projects; and
  3. Heightened operating risk by virtue of hybrid financing model.

Source: AmInvest Research - 13 Jun 2022