For the recent 2Q18 results season, 7 (54%) out of the 13 contractors under our coverage reported core earnings that were below expectations and 6 (46%) were within. Contractors are cushioned by healthy orderbook level following the robust job flows in the past 2 years amid challenging near term industry landscape. We expect overall margin to remain at a low in 2H as contractors may continue to be prudent in terms of margin recognition. Industry players are aiming for jobs in Sarawak as emphasis will be put on state water and rural road projects. Maintain NEUTRAL on construction sector. Our BUY ratings are SunCon, IJM, Rohas and Taliworks.

Higher proportion of those below. For the recent 2Q18 results season, 7 (54%) out of the 13 contractors under our coverage reported core earnings that were below expectations and 6 (46%) were within.

Thin construction margin and timing gap. Kimlun and Mitrajaya results were dragged by low construction margin. This may due to more conservative margin recognition in view of subdued near term industry prospect coupled with higher material price and labour cost. Protasco’s construction segment slump into red due to timing gap between completion of PPA1M Phase 1 and commencement of Phase 2.

Higher finance cost and delay in job. WCT and Pesona’s results were dragged by higher finance costs incurred for new acquisition. Rohas’ result was below mainly due to slow progress billings for projects due to change of government post GE14.

Healthy orderbook level as cushion. Most contractors within our coverage continue to exhibit healthy order book levels with cover ratios averaging 4.9x following the robust job flows in the past 2 years. Nonetheless, 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). Total construction jobs announced on Bursa from Jan-Aug amounted to RM10.5bn and comprised mostly private sector building jobs as opposed to public sector.

Lower construction margin. We expect overall margin to remain at a low in 2H as contractors may continue to be conservative in terms of margin recognition given the slow job flow outlook. The weak job flow outlook also presents risk of potential kitchen sinking activities to be carried out which will hamper margins. Besides, contractors may also increase spending for machinery upkeep as capacity were fully utilized over the last market upturn (past 2-3 years) and lack of maintenance.

Sarawak the next place to be. Job flows in Peninsular Malaysia slowed down significantly following the change in Federal government. We understand that industry players are aiming for jobs in Sarawak as its Chief Minister mentioned emphasis will be put on state water and rural road projects following the decision to shelve Kuching’s LRT project. Funding for those projects is expected to come from Sarawak’s state reserves (c.RM30bn) which may insulate the projects from risk of reduction of federal government spending. The Sarawak Coastal Road and Second Trunk Road projects with estimated combined value of RM11bn are expected to open bidding in the near term.

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 orderbook 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. Our BUY ratings are on SunCon, IJM, Rohas and Taliworks.

Source: Hong Leong Investment Bank Research - 12 Sept 2018