Investment Highlights

• Macro challenges in the sector. The government’s fiscal position has been weighed down by the economic impact of the pandemic and massive relief spending to cushion the consequences. The Finance Ministry projected that consumption subsidy expenditure will reach RM77bil this year, exceeding the RM31bil allocation approved in Budget 2022.
  To reallocate financial resources for the subsidy bill, the government is currently taking austerity measures to optimise public expenditure by deferring or cancelling development projects that have yet to commence. So far, 30 projects worth RM100mil have been identified. According to Datuk Seri Mustapa Mohamed, Minister in the Prime Minister’s Department (Economy), only projects that have not started the procurement process and not been advertised would be shelved. As such, we believe that projects such as the MRT3, Kuching autonomous rapid transit, East Coast Rail Link, RTS and Pan Borneo Highway would not be affected.
  Also, as the national debt remains elevated, we believe the rollout of public infrastructure projects will most likely adopt a private funding initiative. This would reduce the 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.

• Erosions in operating profit margins. We believe that raw material prices would remain high due to global economic uncertainties and geopolitical conflicts. Although steel bar price fell 9% to RM3,205/MT in July 2022 from a peak of RM3,525/MT in Apr/May 2022, it is still 19% higher than RM2,700/MT in Jan 2021 (Exhibit 2). Meanwhile, cement price has risen by 1% YTD in central peninsula, 8% in Kota Kinabalu, and 14% in Kuching since Jan 2022 (Exhibit 3).
  The government had reintroduced the variation-of-price (VOP) clause, which helps contractors manage rising building material costs for government contracts (Exhibit 4). However, most private projects do not have such provisions. While contractors are able to incorporate the rising cost for new tenders in the form of increased contract values, the higher cost would still lead to lower operating profit margin and higher working capital requirements.

• Labour shortage to ease. Contractors who are short on labour have been holding back from bidding for additional jobs, as the shortage may lead to penalties or damage claims from delays in completion. Despite the slow approvals and protracted talks with source countries over employee protection, we expect the shortage of labour to gradually ease over the remainder of 2022. This will allow contractors to prepare for the rollout of mega infrastructure projects, e.g. the MRT3 which is expected to be in 4Q2022/1Q2023.
  We are also positive on the recent lift of Indonesia’s freeze on its workers entering Malaysia effective from 1 Aug 2022. This will benefit Sunway Construction (SunCon), which had obtained approvals for 400 workers from Indonesia before the temporary freeze.

• MRT3 civil work packages estimated to be RM29bil. Our estimates for the contract values are RM2.3bil for CMC301, RM10.6bil for CMC302 and RM16.1bil for CMC303 (Exhibit 5). We believe the MRT3 will not be affected by the austerity measures as it adopts a PFI structure. Barring any delay, we expect these packages to be awarded in 4Q2022/1Q2023 and subcontract awards to be in 1Q2023.
  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 Corp and SunCon as they have a strong balance sheet and proven track records. We expect WCT Holdings’ role to be limited to subcontracting due to the group’s stretched balance sheet. We also believe that Kimlun Corp and Econpile Holdings would benefit from the rollout of these packages as they have won sizeable jobs from the previous MRT projects.

• We are NEUTRAL on the sector. In spite of the potential award of the MRT3 which would revitalise the industry, we are cautious due to the eroding operating profit margins resulting from elevated building material cost and potential delays/cost revisions of mega projects. We would upgrade our call on the sector when the pressure on building material costs eases and the government decides to forge ahead with the implementation of key public infrastructure projects.

Source: AmInvest Research - 3 Aug 2022