Investment Highlights

• Mixed 3Q2022 results. Out of 5 companies, 1 was above expectations, 2 within and 2 below. Kimlun outperformed due to higher-than-expected contribution from the manufacturing & trading segment. The manufacturing & trading segment’s core net profit (CNP) almost doubled QoQ in 3QFY22, supported by positive forex movements and improved sales orders. On the other hand, Sunway Construction (SunCon) underperformed as progress billings from ongoing construction projects were slower than expected. WCT Holdings’ (WCT) profit came in short of expectation as property earnings were below estimates from clearing low margin properties. Meanwhile, IJM Corp (IJM) and Econpile’s earnings were within our expectations.

• Overall sector’s CNP grew 10% QoQ in 3Q2022. This was underpinned by stable construction margins and higher manufacturing earnings. However, revenue contribution was weak as some projects are still in the early stages of construction.

• Near-term slowdown in job flows. There may be delays in the award of government-related projects such as MRT3 in the near-term. The MRT3 project was supposed to be awarded as early as Oct 2022. With the recent change in government, we believe that the award of the main packages and sub-contracts will only take place in 1H2023. According to the Construction Industry Development Board (CIDB), contracts awarded up to Nov 2022 were RM118bil. On an annualised basis, this was 3% lower than the RM133bil awarded in 2021.
  Going forward, we expect a recovery in job flows, especially smaller projects in Western Peninsula and East Malaysia.

• Operating margins may be affected by volatile building material costs. Steel prices in Central Peninsula slid 28% to RM3,132/tonne in Oct 2022 from a peak of RM4,344/tonne (Exhibit 5). Although steel prices may receive a boost from the relaxation of Covid restrictions in China, we think that steel prices would still be volatile due to global economic uncertainties.
  As for cement, we expect prices to remain elevated in line with coal prices (Exhibit 6 & 7). According to market sources, cement prices soared 32% to RM22.50/50kg bag in early Dec 2022 from RM17.00/50kg bag pre-GE15.

• Labour shortages to ease. Contractors facing labour shortages have been holding back from bidding for additional jobs due to the risk of penalties or damage claims that may arise from delays in completion. Also, contractors may have to pay a premium to secure workers to maintain an optimal level of labour force. Nonetheless, we expect labour shortages to ease, allowing contractors to prepare for the rollout of mega infrastructure projects.
  We gather that SunCon has obtained approval for 400 Indonesian workers. Out of these, 100 will arrive by the end of the year. Including the existing 100 foreign workers, SunCon’s foreign workforce will amount to 500 in total. In comparison, SunCon had a peak of 800 foreign workers during the construction of MRT2 and LRT3. Kimlun has also obtained approval for 737 foreign workers (comprised of Indonesians, Nepalese and Bangladeshis), of which 70 have arrived. The balance will arrive in batches by Mar/Apr 2023, which will bring its migrant workforce to 1K (including subcontractors).
  Additionally, DOSM reported that the labour market continued its recovery at a steady pace in 3Q2022, with unemployment rate falling to 3.7% from 4.7% a year ago.

• 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 the rollout of public infrastructure projects in the future would adopt a private funding initiative structure, which could alleviate immediate capital outlays from the government. However, this also means contractors could be required to take on additional risk to participate in the funding of such projects.

• Remain NEUTRAL on the sector. Sector earnings may be hit by a squeeze in operating margins resulting from higher building material costs. We are also wary of the potential delays or cost revisions of mega projects. We may rerate the sector when the pressure on building material costs eases and the government decides to forge ahead with the implementation of key infrastructure projects.

Source: AmInvest Research - 9 Dec 2022