3Q18 domestic contract awards totalled RM5.7bn (+37% QoQ, -27% YoY), bringing 9M18 sum to RM14.6bn (-22% YoY). The QoQ rebound was mainly due to resumption of job flows post GE14 but was still lower YoY due to the review and scrapping of mega projects. We understand that both LRT3 and MRT2 will restructured to a fixed price contract model with lower project size and an official announcement is expected to be out in the near term. Industry players are aiming for jobs in Sarawak as emphasis will be put on state water and rural road projects and funding will be coming from state reserves. Maintain NEUTRAL on the construction sector.

Supported by large scale developments. Domestic contract awards to listed contractors totalled RM5.7bn in 3Q18 (+37% QoQ, -27% YoY). The QoQ rebound was mainly due to resumption of job flows in 3Q coming off a low base period in 2Q due to GE14 factors (i.e. slow job wins pre-polls and transition period post-polls). Nonetheless, contract awards for 3Q18 was still down YoY due to a combination of (i) higher base effect (note that 2017 has the 2nd highest sum of job wins in the past-10 years) and (ii) impact from the cancellation and review of mega projects post GE14. Contract awards during the quarter were mainly driven by 2 huge development projects, namely TRX (RM1.1bn) and Pavilion Damansara Heights (RM1.9bn) which together contributed c.54% to total domestic contract awards in the quarter.

Surprise infrastructure contract awards. Surprisingly, contracts related to mega infrastructure projects amounting to RM1.2bn were dished out during the quarter despite the hold back of mega infrastructure projects post GE14. Nonetheless, we still expect property development projects to continue dominating in the domestic construction contract scene in the near term due to reduced government spending on large scale infrastructure projects. For the cumulative 9M18 period, domestic and foreign contract awards amounted to RM14.4bn and RM258m respectively, decreasing 22% and 78% YoY. Going forward, we do not discount the possibility that more contractors will bid for foreign jobs following the slowdown in the domestic construction landscape.

LRT3. LRT3 works slowed down significantly following review of the project and we gather that an official announcement regarding changing of project model will be out in the near term. Total contract value under the new fixed price contract model is estimated to be at c.RM10bn with potential margin compression for the new main contractor that is converted from the PDP role.

MRT2. We understand that MRT2 will be restructured from PDP to fixed price contract model which is similar to the LRT3 and potential scaling down of size could be as high as RM8bn, which accounted for 25% of original project size (RM32bn). Overall project completion rate is at 28% for PDP portion and 37% for underground portion as at end of Aug-18.

Sarawak the next place to be. Job flows in Peninsular Malaysia slowed down significantly post GE14. 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 LRT project. Funding for those projects is expected to come from Sarawak state reserves (c.RM30bn) which insulates 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 rail projects. The domestic construction industry landscape is expected to remain challenging and we do not expect a significant improvement in the near term. The 22% decline in contract awards thus far into 2018 supports our view. 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.

Source: Hong Leong Investment Bank Research - 5 Oct 2018