MCO came into effect lasting until 31-Mar. MoW published an FAQ, dictating a stop-work order with exception given to critical works. Checks reveal works at TRX and MRT2 (non-tunnelling) will be halted. Limited sections of the LRT3 will continue due to hazard concerns. Significant portions of PBH Sarawak should also come to a halt. Prospects for the sector looks fairly muted due to earnings risks from weaker progress billings and cash flow pressure driven by possible extensions to the current MCO. Additional sector uncertainties emanate from delays in project rollout as well as limited fiscal flexibility to carry out sizable new infra jobs owing to the collapse in oil price. For now, we maintain NEUTRAL due to the steep correction in KLCON (YTD: -37.2%).

NEWSBREAK

MCO. On 18th March 2020, the Movement Control Order (MCO) came into effect as a measure aimed at curbing the spread of Covid-19. Under the order lasting until 31st March 2020, only essential services (construction was excluded) were green lighted for continued operations. Most contractors suspended works pending confirmation from MBAM and industry associations. Subsequent to the MCO, Ministry of Works (MoW) published an FAQ, dictating a stop-work order with exception given to works deem critical where abruptly halted, may pose safety risks to workers and the general public.

HLIB’s VIEW

Critical scope of works. According to the FAQ, works deem critical include slope maintenance, fixing potholes, traffic management, checks on electrical & mechanical parts, critical remediation works at private premises, upgrading facilities of essential businesses, traffic light maintenance, tunnelling works, Bailey Bridge works, emergency works and any other works, if uncompleted poses significant hazard to the public.

Projects impacted. Inevitably, most construction works will come to a halt throughout the MCO enforcement period (most not classified as critical). Checks reveal works at TRX and MRT2 (non-tunnelling) will be halted. Limited sections of the LRT3 will continue due to partially completed dangling structures. Significant portions of PBH Sarawak should also come to a halt. In our view, elevated highways could see some work done while building jobs (most non-critical) would come to a stop.

Tunnelling to go on. Tunnelling works were deemed as critical construction works under the FAQ. We gather some critical tunnelling works for MRT2 are allowed to continue during the MCO. Based on this, we opine tunnelling works for the ECRL could see some progress as well.

Force majeure event. Contractors are seeking extension of time (EOT) from clients for potential delays in execution. This is commonly covered under Force Majeure clause in construction contracts which protects the parties from liabilities in the event of extenuating circumstances (pandemics included). Hence, contractors will be able to avoid performance liabilities (late penalties) but expenses arising from the delay (e.g. fixed overhead, idle costs) will inevitably be borne by the contractor.

Overall. MCO could result in slower construction progress, lower project margins and balance sheet deterioration. Nonetheless, the quantifiable impact of the halt at present looks manageable (merely c.1% slower orderbook consumption assuming a 3.0x cover). For contractors with property segments (IJM, HSL, MRCB, Kimlun & WCT) downside risks is more pronounced with possible downward revisions sales target.

Maintain NEUTRAL. Prospects for the sector looks fairly muted due to earnings risks from weaker progress billings and cash flow pressure driven by possible extensions to the current MCO. Additional sector uncertainties emanates from delays in project rollout (change in government) as well as limited fiscal flexibility to carry out sizable new infra jobs owing to the collapse in oil price. For now, we maintain NEUTRAL due to the already steep correction in KLCON (YTD: -37.2%).

Stock Call Changes

We take this opportunity to recalibrate some of our earnings and valuation parameters. Earning-wise, we tone down our progress billings assumptions and impute lower project margins. For valuations in general, we reduce targeted P/E multiples and increase SOP discounts in-line with elevated market uncertainty.

Source: Hong Leong Investment Bank Research - 23 Mar 2020