PublicInvest Research

Construction - Shot In The Arm

Publish date: Tue, 04 Apr 2023, 10:00 AM
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Prime Minister Datuk Seri Anwar Ibrahim (DSAI), together with his entourage to China, yielded RM170bn worth of investments over the weekend. The four-day official visit witnessed the signing of 19 Memorandum-of-Understanding (MOUs) between Chinese and Malaysia companies. Amongst discussions held was regarding the Belt and Road Initiative (BRI) which commenced as early as 2013. In Nov 2016, BRI efforts intensified when the then-Prime Minister, Datuk Seri Najib Razak (DSNR) signed 14 MOUs from his official visit to Beijing. The 14 MOUs covered various sectors from railways, ports, real estate, steel manufacturing, finance, solar cells manufacturing, bird’s nest, e commerce, pharmaceutical, and information technology. Little is known whether all the 14 MOUs materialised. To-date, only 2 projects worth RM260bn out of the 11 major BRI projects as listed below were terminated due to sovereign debt sustainability.

Despite seeing project terminations, the execution of approved BRI projects brought positive net impact to the sector as a whole. Post DSNR’s visit to Beijing, the value of projects done rose 4.9% on average YoY in 2017-2019. This is in tandem with the growth of net foreign direct investments (FDIs) from China which saw a +222.8% jump YoY on average in 2017-2019. That aside, we also notice significant growth in civil engineering works, up +17.9% / +18.6% / +8.3% in 2017-2019 which we think, are largely attributed to China FDIs since the investments are mainly centered on transport infrastructure projects – in line with BRI’s objective to improve regional trade via supply chain connectivity.

Though details on the RM170bn investment remain fuzzy, we expect to see the potential capital inflow from China benefitting the manufacturing (high-tech) sector followed by digital economy, which could potentially lead to the growth of non residential i.e.: industrial building which includes electrical & electronic factory, data centre, and special trades i.e.: earthworks, construction activities. To recap, in 2022, value of work done recorded +8.8% growth YoY from negative growth in the last 2 years, buoyed by improvement across all construction segment activities. Recovery was strongest in non-residential and special trades segment, chalking up +18.7% and +19.6% YoY growths respectively. To note, total net FDI inflow was a record-high of RM273.1bn in 2022, constituting a 12.9% increase from the previous year. Overall, we are enthused by this development although we believe the sector activities will not see immediate effects coming from this potential FDI inflow. We expect activities to pick up in 2H2023 onwards in addition to the rollout of MRT3 coupled with the expediting of public infrastructure projects in East Malaysia.

Valuation. The KLCON Index is currently trading at 13.7x 5-year forward earnings, below the average forward PE of 15.6x. We expect KLCON to trade at +1SD as we anticipate major infrastructure jobs to take off in 2H2023. To recap, 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 as the sector was revived with big ticket projects i.e.: Bandar Malaysia, ECRL, Gemas-JB & Serendah-Port Klang double tracking, LRT3 and Pan Borneo highway. We do not think it unreasonable for the KLCON to trade at +1SD moving forward given the abovementioned reasons.

We retain our sector top picks, Gamuda (Outperform, TP: RM5.10) and IJM (Outperform, TP: RM1.97) for their strong civil engineering capability and track record in “design and build”. Both companies are lowly-geared, with Gamuda at 0.17x as of 2QFY23 and IJM at 0.24x as of 3QFY23. Outstanding construction orderbook for all stocks in our universe remain optimal at 3-4 years, with Gamuda having a record breaking orderbook of RM20.5bn.

Source: PublicInvest Research - 4 Apr 2023

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