Investment Highlights

• Mixed 4Q2022 results. Out of 6 companies, 1 was above expectations, 3 within and 2 below. Kimlun Corporation (Kimlun) outperformed mainly due to higher-than-expected margin in its manufacturing & trading (M&T) segment. Meanwhile, IJM Corporation (IJM) underperformed due to slower orders flows and WCT Holdings (WCT) from higher-than-expected building material costs. Earnings for Gamuda, Sunway Construction (SunCon) and Econpile Holdings (Econpile) were within our expectations.

• Overall sector’s core net profit (CNP) fell 8% QoQ in 4Q2022. The lower CNP in the quarter was mainly due to Gamuda’s lumpy earnings from the sale of Vietnamese properties and slower progress billings at its construction projects. WCT’s CNP also fell due to higher construction costs and clearing of properties, which were mostly sold at lower prices. However, the fall in the sector’s CNP was partially cushioned by SunCon’s CNP, which doubled due to recalibration of margins for projects nearing completion.

• Order book replenishments. In 4Q2022, Gamuda won RM2.5bil worth of jobs – Taoyuan City underground railway project in Taiwan and M1 motorway extension in Australia. Meanwhile, SunCon’s order book wins in the quarter amounted to RM1.7bil – data centre job in Sedetak Tech Park in Johor. Meanwhile, IJM and WCT did not secure any significant jobs during the quarter.

• Near term slowdown in job flows yet to recover. According to Construction Industry Development Board (CIDB), YTD contracts awarded up to Feb 2023 were RM10.5bil (Government: 24%; Private 76%), 51% lower than the RM21.3bil (Exhibit 4) in the same period last year. Nonetheless, we expect a recovery in job flows, especially projects of smaller scale in East Malaysia, which will benefit small and unlisted contractors.

• Largest ever Development Expenditure (DE) for 2023, revised 2% higher. DE of RM97bil is expected to be 2% higher than the RM95bil in the previous Budget 2023 (excluding the contingency reserve warrant of RM2bil). Out of the RM97bil, RM1.4bil will be funded by debt and RM95.6bill will be funded directly. After adjusting for the 1MDB bond payment of USD3bil (or RM13.5bil @ MYR4.5/USD1.0) due in Mar 2023, DE of RM83.5bil for 2023F will be 17% larger higher than the DE disbursed of RM71.6bil in 2022.
  The bulk of the DE typically goes toward funding basic infrastructure projects – roads, bridges, schools and water supply projects – which benefits small and unlisted contractors. Also, DE includes items rolled over from 2022 as the government had disbursed only RM71.6bil against RM75.6bil allocated for the year.

• Higher allocation for East Malaysia. The allocation for the development of utilities, health, education and infrastructure for East Malaysia – RM6.5bil for Sabah and RM5.6bil for Sarawak – has also been revised upwards by 3% to RM12.1bil from RM11.7bil in the previous Budget 2023. It is also 23% higher than the RM9.8bil allocated for both states in 2022. The new allocation includes RM1bil for the development of cities bordering Kalimantan, Indonesia such as Kalabakan, Sabah and Ba’kelalan, Sarawak and RM2.5bil allocated for public infrastructure. We also expect the development to be expedited for Pan Borneo Sabah and Sabah-Sarawak Link Road (estimated to cost RM20bil).

• RM17.6bil earmarked for transport – 7% higher than RM16.5bil in the previous Budget 2023. The mega projects mentioned in Budget 2023 are not new. Given the PM’s lack of interest in legacy landmark projects and the elevated national debt, we do not expect any new mega projects to be announced in the future.
• Concerns over funding remain due to the country’s stretched fiscal position – from the economic impact caused by the pandemic and massive relief spending to cushion the consequences – and elevated national debt of RM1.2tril, excluding liabilities.
  It was also recently reported that the hybrid funding model for MRT3 may be scrapped and the development will be funded by the government, presumably via debt issuance by DanaInfra Nasional. Although the move to debt financing may provide even more clarity and stability to the project, thereby benefitting the contractors involved, the issuance of debt could raise the government’s debt even further and potentially affect the country’s credit rating.

• Lower price tag for MRT3 within expectation. The government is confident that it would be able to reduce MRT3’s cost by 10% to under RM45bil, from RM50bil committed by the previous administration. MRT Corp is currently conducting a detailed and comprehensive study on the proposed MRT3 alignment, including the suitability of realignment. As the government seeks to reduce the cost of the project, we think a major realignment of MRT3 is unlikely.
  Notwithstanding the above, we expect the tender awards for the main packages and subcontracts to take place in 2H2023. This is after the completion of the public inspection of the MRT3 railway scheme and study of the proposed alignment and suitability of realignment. Currently, the 3 work packages are CMC301 (5.8km elevated), CMC302 (28km elevated and 0.7km underground) and CMC303 (6.3km elevated and 10.1km underground)

• Flood mitigation projects above RM600mil to commence in Jun 2023. During the re-tabling of Budget 2023, PM announced that 6 flood mitigation projects would be re-tendered by June 2023. Following the floods in Johor, flood mitigation projects above RM600mil will be expedited and commence in June 2023. Potential beneficiaries include established contractors like Gamuda and IJM.

• Other civil works allocation include:
  a) Development to enlarge and increase the capacity of Penang International Airport and Subang Airport, to be spearheaded by Malaysia Airport Holdings (expected to be lower than RM7bil).
  b) Construction of a port in Sanglang, Perlis for handling of petroleum and bulk cargo, as well as developing a port in Pulau Carey, Klang.
  c) Construction of beach erosion structure between Kuala Sanglang, Perlis and Kuala Jerlun Kubang Pasu, Kedah.
  d) RM2.7bil to repair and upgrade federal road, of which RM300mil is for G1 to G4 contractors for maintenance of smaller scale.
  e) RM1.5bil to upgrade and construct new roads to improve the connectivity of rural areas.
  f) Construction of an overtaking lane in Senai Desaru Expressway to improve the connectivity of highways to Pengerang and RM525mil allocated to upgrade North-South Highway from Yong Peng Utara to Senai Utara from 4 lanes to 6 lanes.
  g) RM480mil for construction of a new road from Habu to Tanah Rata, Cameron Highlands, Pahang.
  h) RM300mil allocated to construct roads and Sungai Sepang Bridge to connect Bukit Pelandok, Port Dickson and Sungai Pelek, Sepang.
  i) RM700mil for construction of a 476-bed female and children block in Hospital Melaka.

• Operating margins may face compression. Steel prices rose 4% to RM2,788/tonne in Jan 2023 from the low of RM2,686/tonne in Nov 2022 (Exhibit 5) while bagged cement prices rose to RM19.23/50kg – 8% higher than RM17.83/50kg bag in Jan 2021 (Exhibit 6). Looking ahead, we expect steel prices to rise as China’s reopening is expected to lift demand for metals. Additionally, a multi-tiered levy for the migrant workforce will be introduced in 2023F, which may lead to higher labour costs.

• Overall, we are NEUTRAL on the construction sector. Although the sector is expected to enjoy a higher DE, we think that it favours smaller contractors – most of whom are unlisted. Sector earnings may also be hit by a squeeze in operating margins due to higher construction costs.

Source: AmInvest Research - 9 Mar 2023