• Malaysian construction companies have shown tremendous agility and resilience as it managed to navigate against major upheavals from political and Covid-19 challenges in recent years. This was done via venturing into new geographical market and business segment as well as implementing effective cost management.

• While dependency on foreign labor is still prevalent, we believe that labor shortage is no longer a critical issue at this juncture. We also believe cost pressures from weak ringgit and higher construction building material prices are still manageable.

• As the worst is over, we anticipate a full rebound in 2024, with several overdue projects expected to be in the pipeline. Against this backdrop, we expect these companies to thrive.

• Maintain an OVERWEIGHT recommendation on the sector with anticipation of pump-priming measures namely MRT3, Penang LRT and highway expansions coupled with growth opportunities in industrial property market and renewable energy. We have BUY call for Gamuda (TP:RM5.16) and AQRS (TP:RM0.49) while HOLD call for SunCon (TP:RM1.99).

Construction Sector From A Rear Mirror View

The construction sector has faced significant challenges over the past few years. Initially, it grappled with disruptions stemming from changes in government fiscal policy. Several mega projects were reviewed and cancelled following the changes in the federal government back in 2018. Subsequently, the sector also contended with a slowdown due to the Covid-19 pandemic. As a result, the value of construction works contracted at a 4-year CAGR of 5%, reaching RM54bn over the period from 2018 to 2022 (Refer to Chart 2). Notably, the KL Construction Index mirrored this decline since 2018 (Refer to Chart 1), reflecting the persistent issues surrounding the sector.

Survival of the Fittest

In general, most construction companies were impacted by similar macro challenges. Nonetheless, we observed that many companies have successfully managed to mitigate these risks in the post-pandemic landscape. Under our coverage, Gamuda has effectively expanded its footprint in the overseas market, with a dominant portion of its construction order book in FY22-23 originating from Australia. Meanwhile, Sunway Construction (SunCon) has entered the renewable energy sector and is actively involved in the construction of industrial properties and data centers. Additionally, Gabungan AQRS (AQRS) has implemented a prudent tendering strategy and effective cost management, ensuring the successful completion of projects within budget, while simultaneously advancing its property segment.

Light at the End of Tunnel

Overall, we see a positive and healthy trend as construction activities has bottomed out and resumed gradually in 3Q2021 (Chart 4). Notably, the construction sector's overall growth has been primarily propelled by civil engineering works, particularly various roads, and rail infrastructure projects. Despite this, we anticipate a full rebound in 2024, with several overdue projects expected to be in the pipeline. We also anticipate a substantial growth in 2024, as the political uncertainties surrounding the construction sector have dissipated. This positive outlook is further bolstered by the allocation of RM90bn for Development Expenditure, with a further revision to RM415bn (from RM400bn) for the 12th Malaysia Plan.

As a testament to this anticipated recovery, construction activity saw a 9.6% YoY increase in 3Q2023 (Refer Chart 4), maintaining a positive trajectory for the sixth consecutive quarter. This growth is significantly influenced by heightened output in civil engineering (40.5% compared to 37.4% in 2Q2023) and special trade activities recorded 16.2% growth, compared to 9.8% in 2Q2023 (Refer Chart 5). The surge is mainly attributed to the construction of roads and railways, driven by the acceleration of projects like LRT3, Pan Borneo, and ECRL. Conversely, there has been a slowdown in output for residential (21.9% compared to 22.7% in 2Q2023) and non-residential (27.5% compared to 30.7% in 2Q2023) buildings, reflecting the sluggish progress in the property market.

Dependency on Foreign Labor is Still Prevalent

Malaysian construction industry faces a significant labor market challenge, with local workers unable to meet demand. Approximately 70–80% of the workforce comprises foreign laborers, primarily from countries like Indonesia, Nepal, Myanmar, and Bangladesh. To address the labor shortage, the government initially relaxed conditions for hiring foreign workers, leading to a substantial excess. However, in March 2023, further approvals for new quotas were halted, with a focus on managing entry based on approved quotas, aiming to cap foreign workers in Malaysia at 2.4mn by 2025. The Human Resources Ministry has quoted that, they are expecting the arrival of 152,158 foreign workers to meet local industry needs, supplementing the existing 1.83 million foreign workers in the country on temporary employment visit passes (PLKS) as shown in Table 1. While unskilled workers, mainly from Bangladesh, have filled the labor gap left, as total of 150,000 foreign workers, mainly Indonesians, have left Malaysia since last year, unable to return to the country due to the MCO, and thus leaving about 330,000 foreign workers in the construction sector. Nevertheless, we believe the labor shortage is no longer a critical issue. Looking ahead, we anticipate government efforts to incentivize industries to adopt digitalization, mechanization, and automation, boosting demand for skilled workers and encouraging local upskilling.

Impact of Weak Ringgit and Higher Building Material Prices Are Still Manageable

The Malaysian ringgit is currently experiencing a period of gradual depreciation against the US dollar. The swift implementation of the Federal Reserve's tightening monetary policy has led to a significant appreciation of the US dollar, directly affecting the currencies of emerging markets, including the ringgit. Despite this, Malaysia's overnight policy rate (OPR) has remained at 3.00% since July 2023, placing it at a historically low level compared to the upper range of the Federal Reserve's benchmark (5.25%-5.50%). Consequence of the weakened ringgit, material cost is escalating which ultimately leading to a decrease in profit margins.

Meanwhile, the average cost of construction materials has demonstrated overall price stability in 2023, trending downward toward pre-pandemic levels (Refer Chart 6). Despite this positive trend, it is notable that the price of cement has not followed suit, experiencing a significant 26% increase since October 2022 (rising from RM17.00/kg to RM22.94/kg in October 2023). However, we anticipate a gradual upward movement in average prices of building materials over time due to sustained demand for construction materials, driven by the upcoming busy domestic infrastructure projects in 2024. These projects shall include MRT3, Penang LRT, the revival of five stations on LRT3, and highway expansion. Nevertheless, we remain optimistic that, at this juncture, the challenges posed by increasing costs are manageable, especially for companies with a robust financial position, such as Gamuda and SunCon.

Resilience in Motion

Malaysia's construction landscape has navigated a spectrum of challenges and opportunities. The gradual depreciation of the Malaysian ringgit, influenced by global economic factors and Federal Reserve policies, has posed challenges such as increased material costs and decreased profit margins. However, the sector has showcased resilience, experiencing a rebound in 2023 driven by accelerated projects and sustained demand for construction materials. Concurrently, political changes have introduced disruptions, leading to a contraction in overall growth. Notwithstanding these challenges, key industry players demonstrated exceptional adaptability, indicating promising prospects for growth. All in all, we believe the sector is poised for continued growth with anticipated local infra development projects, coupled with growing demand in emerging areas, namely industrial property market, data centers, and renewable energy.

Overweight on the sector

We have an OVERWEIGHT recommendation on the sector with anticipation of pumppriming measures namely MRT3, Penang LRT and highway expansions coupled with growth opportunities in industrial property market and renewable energy. We have BUY call for Gamuda (TP:RM5.16) and AQRS (TP:RM0.49) and HOLD call for SunCon (TP:RM1.99).

Source: BIMB Securities Research - 14 Nov 2023