Highlights

• Lacking sizable contracts. Domestic contract awards to listed contractors in 2Q17 amounted to RM4.1bn (-39% QoQ, -49% YoY). Sizable job wins were lacking during the quarter with only 1 contract exceeding RM500m (Bintulu Port supply base wharf). In comparison, contract awards in 1Q17 (RM6.6bn) and 4Q16 (RM6.8bn) were boosted by several MRT2 viaduct packages.

• Falling from an exceptionally high base. On a cumulative basis, 1H17 domestic contract awards totalled RM10.7bn, declining 72% YoY. The steep fall was attributed to an exceptionally high base last year due to the award of the MRT2 underground works (RM15.5bn), DUKE3 (RM3.7bn) and Sarawak Pan Borneo Highway packages (RM3.2bn).

• Job flows to pick up in 2H. We expect the flow of contract awards to pick up in 2H, aided by the rollout of LRT3 (RM9bn). Channel checks with contractors reveal that several tenders have been called and are undergoing evaluation.

• Normalisation setting in. Given the significantly higher base for 2016 at RM56bn (all time high), we expect a downward normalisation in 2017 to RM25bn. With 1H numbers forming 43% of our full year target and expectations of a stronger 2H, we reckon this target is on track. Despite the downward normalisation expected in 2017, this remains at the higher end of the historical range from 2009-2015 of RM10-28bn.

• Picking up in 2018. We reckon that job flows could pick up strongly next year fuelled by the impending rollout of mega rail projects such as the ECRL (RM55bn), HSR (RM60bn) and MRT3 (RM50bn).

• Flattish for foreign jobs. Foreign contract flows in 2Q17 stood at RM631m (+31% QoQ, -20% YoY), bringing the 1H sum to RM1.1bn (+3% YoY).

Risks

• Soft domestic property market, leading to slower private sector contracts.

Rating

Maintain OVERWEIGHT

• We expect a strong revival in job flows next year, driven by the several mega rail projects. The significance of these mega rail projects to the construction sector should not be underestimated. To illustrate, job wins hit a high of RM28bn in 2012 and RM56bn in 2016 when the MRT1 and MRT2 was rolled out.

Top Picks

• Gamuda (BUY, TP: RM6.24) is our top large cap construction pick as it is set to see earnings hit multi-year highs in FY18 and FY19.

• For the small caps, we like GKent (BUY, TP: RM5.60) and Pesona (BUY, TP: RM0.81) as they both offer superior earnings growth and strong ROEs.

Source: Hong Leong Investment Bank Research - 7 Jul 2017