Highlights

• Flattish spending for 2017 but... Development expenditure for 2017 has been set at RM46bn, flattish at +2% YoY. This should help sustain nominal construction output given its strong correlation (73%) to development expenditure.

• ...picking up later on. 11MP (2016-2020) has an allocation of RM260bn, 13% higher than 10MP. Subtracting the RM45bn allocation for 2016 and RM46bn for 2017 leaves a balance of RM169bn for 2018-2020. Assuming this is spreaded equally over 3 years, spending momentum could pick up strongly in 2018 by +22% to RM56bn.

• Outperformance continues. Real construction growth has outperformed overall GDP since 1Q12. Our economics team expects the outperformance of construction to persist into 2017 at 10% against an overall GDP growth of 4.5%.

• A year of normalisation. 2016 witnessed a record showing of contract flows at RM56bn which was up +158% YoY and also surpassed the previous high of RM28bn in 2012. Coming from a significantly higher base, it would only be rational to expect a downward normalisation in job flows for 2017 and expect this to come in at RM25bn.

• Rollouts for the year. Expected mega projects for 2017 include remaining packages of the MRT2 (RM5bn) in 1H, LRT3 (RM9bn) awards to begin in 1Q and potentially the mammoth ECRL (RM55bn) towards end 2017 at earliest.

• Boost from Greater KL. Several catalytic developments have emerged in Greater KL which include TRX, Warisan Merdeka, BBCC, Bandar M’sia, Kwasa D’sara and CCC. Collectively, these developments have GDV of at least RM275bn and could potentially generate RM138bn worth of works for contractors to undertake.

Risks

• The key risk is a softening domestic property market which may see slower job flows from private sector developers.

Rating / Valuation

OVERWEIGHT

• While we expect a downward normalisation in job flows for 2017, we retain our OVERWEIGHT rating on the sector. The strong contract flows registered last year will translate into earnings growth for 2017.

Top Picks

• Gamuda (BUY, TP: RM5.67) is our top pick amongst the large cap contractors as it is set to see a revival of earnings growth in FY17 and potentially a new high in FY18. Catalysts include the MRT3, PTMP and sale of SPLASH.

• For the small caps, we like GKent (BUY, TP: RM3.77) as a key rail play (LRT ext, LRT3 and MRT2). It has 3-year earnings CAGR of 28%, above industry ROE and net cash.

• We also like Pesona (BUY, TP: RM0.81) as it offers exposure to a pure construction play with incoming recurring income stream. 3-year earnings CAGR is projected at a robust 61% on back of increasing ROE and net cash position.

Source: Hong Leong Investment Bank Research - 10 Jan 2017