Sector performance in 1H2022 was dismal, affected by sector headwinds led by the pandemic followed by inflation. Profit margins were depressed as key building materials such as steel and cement prices reached an all-time high in 1H2022. However, in 2H2022, we see improvements in profitability across the companies under our coverage as building material prices came off from their peak albeit, overall price remain elevated. On labour issue, manpower has yet to recover to pre-pandemic level but recorded an +12.2% improvement on the headcount of general construction worker from 1H2022. Going into 1H2023, we anticipate excitement as both public and private job flows regained its momentum – projects awarded up two-fold in 2H2022. While we see aplenty sector-related news flow under Prime Minister Dato Seri Anwar Ibrahim (DSAI)’s administration, we view the ‘equitable distribution’ policy favourable to the sector as it points towards ramp-up development in the underdeveloped states of the country. Sector valuation is attractive, the KL Construction (KLCON) Index trading at 12.1x 5- year forward earnings, below 5-year PE from 2012-2017 at an average of 14x 5-year forward earnings. Hence, we upgrade our rating to Overweight on the sector due to the abovementioned reasons.

• Lookout to the east. For the past few weeks under PH’s administration, Prime Minister DSAI has promptly addressed economic gap and inequalities between Peninsular and East Malaysia. We opine that developments in East Malaysia and underdeveloped states in east Peninsular i.e.: Kelantan, Terengganu will be ramped up following the appointment of DSAI’s Cabinet which saw 7 out of 28 ministerial posts filled up by representatives from East Malaysia. On top of that, PH coalition (as the then-opposition), in its Alternative Budget 2022 and 2023 has proposed larger and equitable allocations to all 14 states in Malaysia.

• Sunlight is the best disinfectant. The current Government shunned procurements of projects without proper tenders, resulting in a review of RM7bn worth of approvals flood mitigation projects. While this have cast uncertainties on the flow of projects, we are less concerned as the sector’s immediate catalyst, MRT3 is done through an open tender. Consequently, we believe listed contractors will stand to win a fair share of projects as they appear to have higher levels of transparency and advantage, in terms of ability to raise capital.

• Our outlook: Overweight. The KLCON Index is currently trading at 12.1x 5-year forward earnings, within the average forward PE of 11.7x. We expect KLCON to trade at 1SD moving forward as major infrastructure job flow momentum to pick up next year, coupled with the favourable domestic policy. We take reference of the 5- year PE from 2012-2017, excluding the years in between 2018-2022 as the anomalies were due to political uncertainties in 2018 followed by the COVID-19 pandemic. Based on average sector valuation prior to GE14, construction stocks were trading at an average of 14x 5-year forward earnings. Our top picks are Gamuda (Outperform, TP: RM4.30) and IJM (Outperform, TP: RM1.97).

Source: PublicInvest Research - 3 Jan 2023