The Economic Affairs Minister announced that the ECRL (RM81bn) has been scrapped and final compensation sum will be determined by the Finance Ministry. Option of downsizing has been dismissed by the government as the downsized project costs were still unaffordable. The news of cancellation of ECRL is a negative surprise to construction sector as there were expectations that the project will be downsized like LRT3 and MRT2 instead of an outright cancellation. Maintain NEUTRAL on construction post GE14 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. Nonetheless, high orderbook levels (average cover ratio of 4.5x) and rock bottom valuation (0.7x P/B) should cushion further downside amid subdued near term industry prospects.

NEWSBREAK

Economic Affairs Minister, Mohamed Azmin Ali announced that East Coast Rail Link (ECRL) (RM81bn) has been scrapped and final compensation sum will be determined by the Finance Ministry. This project has been suspended since July 2018 after being discovered that its cost has bloated to unjustified levels.

High development cost is the main reason behind the decision as government would have to incur interest cost of up to RM500m p.a. if the ECRL is not cancelled. Option of downsizing has been dismissed by the government as the downsized project costs would still be unaffordable.

HLIB’s VIEW

Negative surprise. The news of cancellation of ECRL is a negative surprise to construction sector as there were expectations that the project will be downsized like LRT3 and MRT2 instead of an outright cancellation. We expect there will be downwards pressure on construction stocks in the near term following this news as pessimistic sentiment on the sector has been partially alleviated YTD (KLCON index: +13.2%).

Impact to listed work contractors. About RM18-24bn of contracts will be removed as 30-40% of ECRL jobs will be taken up by local contractors based on our estimates. Listed companies that have received work packages are HSS Engineers and Lafarge (SELL; TP: RM1.81). Besides, Gabungan AQRS which is seen as top contender for ECRL work packages may also be negatively affected.

Basic infrastructures the priority. We expect smallish basic infrastructure projects such as road upgrading, hospital, water, sewerage and rural area development projects will be the top priority for government infrastructure spending now which we believe is insufficient to spark any enthusiasm back towards the sector.

Forecast. Maintained earnings forecast on our coverage as earnings contribution from ECRL project has been removed after it was suspended last year.

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 39% decline in contract awards in 2018 supports our view. Nonetheless, high orderbook levels (average cover ratio of 4.5x) following the robust job flows in the past 2 years coupled with rock bottom valuation (0.7x P/B) should cushion further downside amid subdued prospects.

Source: Hong Leong Investment Bank Research - 28 Jan 2019