The HSR and MRT3 have been scrapped while terms of the ECRL are being renegotiated and LRT3 has been downsized. We believe MRT2 may be the next project to be subjected to cost reduction. A new deadline of 4 Aug to conclude SPLASH deal has been set by the new government and we are optimistic towards the near term settlement. Maintain NEUTRAL on the sector. Maintain HOLD and raise TP for both GKent and MRCB after adding back LRT3 NPV contribution. Maintain BUY with higher TP for Taliworks after adding back receivables owed by SPLASH.

Review of mega projects. Post GE14, the new Pakatan Harapan (PH) government has embarked on a review of all mega projects, as promised in its manifesto. HSR (RM60-70bn) and MRT3 (RM40bn) were shelved shortly thereafter. Although there were reports regarding revival of these projects, we reckon that chances are slim in the near term. ECRL has been suspended pending further renegotiation which is expected to be conducted during the Finance Minister’s visit to China at the end of this month. LRT3 has been approved to continue at a reduced total cost of RM16.63bn and cost rationalisation measures such as extension of construction timeline from 2020 to 2024 and restructuring of project from PDP model to a “fixed price contract”.

MRT2 next? We opine that next mega project that is likely to undertake cost-cutting measures is MRT2 (RM32bn). Listed companies that are expecting to be negatively affected are Gamuda and MMC (PDP role and underground package of RM15.5bn), Ahmad Zaki (2 work packages amounted to RM1.7bn), IJM (RM1.5bn viaduct package), Suncon (3 work packages amounted to RM1.5bn), GKent (RM1bn track works), WCT (2 work packages amounted to RM1.1bn) and Gadang (RM952m viaduct package).

2H18 job flows. In 1H18, domestic contract awards to listed contractors totalled RM8.7bn, decreasing 18% YoY. We expect a slowing in job flows in 2H following downsizing of mega projects, with 2018 contract awards to end at RM15bn, a steep decline from 2017 (RM29bn) and 2016 (RM56bn).

Toll abolishment. In its election manifesto, PH also promised to review all highway concession agreements, taking over every toll concession with the ultimate aim of abolishing highway tolls in stages. Up till now no decision has been made by the new government. We opine that a full toll abolishment without fair compensation scenario is unlikely as this will spook investor confidence which may affect funding for future infrastructure development plan.

Water deal. A new deadline of 4 Aug to conclude the SPLASH deal has been set by the new Minister of Water, Land and Natural Resources and assurance has been given that the issue would be settled before the new deadline. Major beneficiaries from settlement of the deal are Gamuda and KPS via 40% and 30% stake in SPLASH respectively and Taliworks via the recovery of RM638m receivables (as at 31 March 2018) owed by SPLASH. Besides, pipe manufacturers such as Engtex, Hiap Teck, Choo Bee and YLI may benefit from rollout of pipe-replacement projects in order to curb Non-Revenue Water (NRW) problem post SPLASH deal.

Maintain NEUTRAL. Maintain NEUTRAL on construction post changes in federal government and scrapping of mega projects. The domestic construction industry landscape is expected to remain challenging and we do not expect a significant improvement in near term. Nonetheless, high order book levels (average cover ratio of 4.9x) following the robust job flows in the past 2 years should help sustain construction earnings amid subdued near term industry prospects.

Stock Call Changes

LRT3 PDP Role (GKent & MRCB)

Since the total project cost of LRT3 has been halved (from RM31.65bn to RM16.63bn), we assume the PDP fee contribution from the project will reduce correspondingly. Although the project has been restructured to ‘fixed price contract’ model, we opine that our assumption of fee reduction is consistent with the new model as the model is part of cost-cutting measures. As such, we cut GKent FY19-21 earnings by 9.5%, 14.5% and 23.6% respectively. For MRCB, we cut FY18-20 earnings by 10.0%, 11.2% and 15.2% respectively. Despite the earnings cut, we raise GKent’s TP to RM1.27 (from RM1.17) and MRCB’s TP to RM0.65 (from RM0.63) after adding back the LRT3 NPV contribution into their respective SOP valuation. We opine that our previous bear case scenario of no LRT3 contribution to SOP may have been too conservative following last week’s announcement that the project will continue amid a scaled down basis. Maintain HOLD for both GKent and MRCB.

Taliworks

We are optimistic towards the near term settlement of SPLASH deal due to greater cooperation between federal and state governments. As such, we add back receivables owed by SPLASH amounted to RM638m into our SOP valuation. Maintain forecast. Maintain BUY with higher TP of RM1.29 (from RM1.00) after adding receivables owed by SPLASH and model adjustment.

Source: Hong Leong Investment Bank Research - 17 Jul 2018