Investment Highlights

• Disappointing 2Q2022 results. Out of the 5 companies under our coverage, 4 results in 2Q2022 were below expectations with only Sunway Construction (SunCon) coming in within our expectations. IJM Corp’s (IJM) earnings did not meet expectations due to lower recognition of revenue and margins as most projects are still in the early stages of construction. WCT Holdings’ (WCT) earnings were dragged by high construction costs for ongoing projects while Econpile Holdings (Econpile) registered a wider loss than our estimates due to smaller-than-expected order book wins together with high labour and raw material costs. Likewise, Kimlun Corp (Kimlun) underperformed due to lower recognition of construction progress and higher-than-expected raw material costs.

• Rising costs affected sector performance. Sector earnings fell 17% QoQ in 2Q2022 due to high construction costs, attributed to elevated building material and labour expenses. Revenue recognition was also low as most of IJM projects are still in the early stages of construction.

• Operating margins to stabilise. We believe most building material costs have reached its peak in 2Q2022. Steel price slid 9% to RM3,205/tonne in Aug 2022 from a peak of RM3,525/tonne in Apr/May 2022 (Exhibit 3). Nevertheless, it is expected to be higher than Jan 2021 levels due to global shortages. Although the cement price trajectory appears to be losing its upward momentum (Exhibit 4), we believe that it would still be elevated in line with coal prices (Exhibit 5).

• Labour shortage to ease. Contractors who are short on labour have been holding back from bidding for additional jobs given the risks of penalties or damage claims arising from delays in completion. Contractors like WCT are also paying a premium to secure workers in order to maintain an optimal level of its labour force. Despite the slow approvals and protracted talks with source countries over employee protection conditions, 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 packages, which are expected to be awarded in 4Q2022/1Q2023.
  We gather that SunCon has obtained approval for 400 Indonesian workers, of whom 100 will be arriving in Sep 2022 and the remaining 300 by Dec 2022, whereas Econpile has secured approval for 250 foreign workers.

• Macro challenges in the sector. The government’s fiscal position has been crimped by the economic impact of the pandemic and the massive relief spending to cushion the consequences. Furthermore, 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 2 civil work packages for the MRT3 are ongoing. Tender for CMC301 closed on 30 Aug 2022, while the tender submission deadline for CMC302 and CMC303 has been extended to 30 Sep 2022. We estimate the contract values for CMC301 to be RM2.3bil, CMC302 to be RM10.6bil and CMC303 at RM16.1bil (Exhibit 6). MRT Corp recently appointed HSS JV as the project management consultant for a contract sum of RM997.9mil. Barring any delay, we expect these packages to be awarded in 4Q2022/1Q2023. Subcontract awards are envisaged to take place 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 and SunCon as they have strong balance sheets and proven track records. WCT has indicated that it is bidding for the CMC301 portion of the MRT3. We also believe that Kimlun and Econpile would benefit from the rollout of these packages as they have won sizeable jobs from the previous MRT projects.

• We stay NEUTRAL on the sector. In spite of the potential award of the MRT3, which would revitalise the industry, we are cautious as the increase in construction costs may erode operating margins. We are also wary of 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 - 8 Sept 2022