Highlights

• 2018 to see flattish spending but... Development expenditure for 2018 has been set at RM46bn (+0.2% YoY). Despite being flattish YoY, this is still the highest posted in the past 6 years. This should help to sustain nominal construction output given its strong correlation (71%) to development expenditure.

• ...potential to pick up later on. 11MP (2016-2020) has an allocation of RM260bn, 13% higher than 10MP. Subtracting the RM134bn for 2016-2018 leaves RM126bn to be spent for the remaining 2 years (i.e. 2019-2020). Assuming this is spread equally over 2 years, this equates to RM63bn p.a., a strong potential jump of 37% from 2018.

• Healthy financing flows. Loan disbursement and approvals to the construction sector grew 13% and 20% YoY (as of Oct 2017), indicating that financing continues to be available.

• Outperformance to resume. Real construction growth has outperformed overall GDP since 1Q17. This magnitude diminished in 2017 with real construction growth at 6% (GDP: 5.8%) due to a high base effect and timing gap for mega projects. However, we expect this outperformance to resume in 2018 with real construction growth at 9% on back of an overall GDP of 5.3%.

• Contract flows to sustain. Domestic contract awards to listed contractors totalled RM29bn for 2017. While this was a 48% YoY decline (due to the exceptionally high base in 2016), it was still the 2 nd highest sum recorded since 2009. We believe the momentum should be sustained YoY for 2018 and target RM25-30bn for the year.

• Mega jobs on the cards. We have identified RM168bn worth of mega projects that will be rolled out over the next 1- 2 years. In our view, the ECRL (RM55bn) and Pan Borneo Sabah (RM13bn) should take off this year while the HSR (RM60bn) and MRT3 (RM40bn) will be implemented in 2019. While some of the projects will be led by foreigners, we have estimated the overall local content of these projects to stand at RM85bn (51% of project value).

Risks

• The key risks are a soft domestic property market and heightened competition from foreign contractors.

Rating / Valuation

Maintain OVERWEIGHT

• We retain our OVERWEIGHT rating on the construction sector premised on the continued robust flows of jobs. Furthermore, most contractors are already sitting on record high orderbook from strong job wins in the past 2 years.

Top Picks

• Our top picks are centred on the rail theme - Gamuda (BUY, TP: RM5.95) and GKent (BUY, TP: RM4.31) . We also like WCT (BUY, TP: RM2.29) for its earnings revival as driven by its new management team.

Source: Hong Leong Investment Bank Research - 16 Jan 2018