We expect contract awards and news flow to pick-up in 2H20 driven by ECRL and sector key events (Budget 2021, HSR & RTS deadlines). Contract awards have been anaemic in 1H20 disrupted by a combination of political fiasco and MCO. Contractors under our coverage are operational with works gradually ramping up. Maintain sector NEUTRAL on construction. Despite recent positive mega project news flow, we believe this of largely offset by weaker private jobs outlook. Key downside risks include: (i) political leadership changes/hung parliament, (ii) resurgence of Covid-19 cases and (iii) labour constraints. Our top pick is SunCon (BUY, TP: RM2.10).

Less work done, slower DE. Value of construction works done in 1Q20 amounted to only RM35b representing declines of -6.4 YoY and -5.4% QoQ with the MCO being the key contributing factor. Construction works done are set to bottom in 2Q20 having seen gradual works resumption underway since 4 May (c.30% of all construction sites are operational as at mid-June). Under Budget 2020, allocated DE was RM56b (4.3% YoY) of which disbursement was hampered by political changes and Covid-19. With the PRIHATIN stimulus, we understand that an additional RM23b of fiscal injections has been classified as DE (to ensure positive primary balance).

Sarawak. Job prospects remain supported by state funded projects like the Sarawak Coastal Road Network (SCRN) as well as Second Trunk Road Project (STR). Gearing up to the state elections in 2021, we expect the rollout of such projects to accelerate where funding is covered by the state’s ample reserves. Recent developments regarding Sarawak’s impending finalisation of its petroleum sales tax agreement with Petronas would award the state with c.RM2b of unpaid 2019 petroleum sales tax, further boosting its coffers. By comparison, 2020 state budget for development expenditure amounts to RM9.9b (all time high). In our view, a rapid deterioration in economic fundamentals brought upon by the pandemic would necessitate a faster roll out of state projects coupled with possible flow of new federal projects driven by warmer state and federal relations. Other on-going projects in Sarawak include water grid and various waste management projects.

Anaemic job flows. Domestic contract awards to listed contractors for 2Q20 came in at -66% YoY and -71% QoQ. On a cumulative basis, domestic awards were down - 39% in 1H20. While contract awards have been anaemic in 1H20, we expect a mild pickup in 2H20. Comfortingly, Perikatan Nasional (PN) government has reiterated their commitment towards ensuring execution of projects under Budget 2020. Notably, some ECRL Section B job awards for initial works have materialised going to Gadang (RM82m), AQRS (RM37m) and Ho Hup Construction (RM103m). Gadang’s management has placed conservative margin guidance of 3-5% after factoring in Covid-19 impact (possibly from SOPs). Recently, Section A was also given final approval which could result in job awards toward the end of 2020. Meanwhile, Section C which saw heaviest realignment by the PH government completed its public inspection period recently. However, latest reports suggest potential realignment for Section C (Mentakab-Port Klang) whereby the BN era alignment crossing through Bentong to Gombak (involves a 16km tunnel) could make a comeback. Costs for the latter are certainly higher (estimated RM8b or more) and could require reworking the existing financing structure. Despite potential implementation delays for Section C, they may not be substantial as previous alignment has undergone public inspection in 2017. Another mega project, Pan Borneo Sabah has been rather quiet, derailed by political leadership changes but the new government has reiterated its intent on speeding up its progress. We believe an ailing economy will provide the impetus for the government to reaccelerate the project. Up north, Penang Transport Masterplan (PTMP) PDP signing was formalised with fee ranging between 5.0%-5.75%. Reclamation works for Island A is targeted to commence in CY21. In terms of funding, the appointed PDP is extending a RM1.3b bridge loan with the remaining gap bridged by state issued bonds. We reckon chances for federal involvement in the project is slim to nil. Recent cancellation of the Penang Hill cable car project (RM100m) despite being included in Budget 2020 point towards increasingly frosty relations between state and federal government. As such, rolling out the overall PTMP may be slow, depending on funding and land monetisation progress. Down south, negotiations for the RTS are close to completion (only 2 issues out of 222 issues remain unresolved). If things go swimmingly, construction works could start as early as Nov-20.

Toll disposal, unlikely. From our understanding, the new government has not engaged concessionaires with regards to a disposal. Originally, the basis of the proposal was to fulfil promises in PH’s election manifesto. Nonetheless, this allegedly attracted opposition within the previous cabinet leading to repeated extensions to its implementation. We opine the transaction may take a backseat as the current government is rolling out multiple stimulus packages focusing on higher impact areas. Additionally, PN is not incentivised to push for the disposal as it is not bogged down by a manifesto.

Gradually gaining momentum. Despite being green lighted for work resumption on 4 May 2020, only c.30% of all constructions sites are back (as at 14 June). Subsequent to this, in early July CIDB has disclosed only c.23% of sites are offline suggesting a quick ramp up towards the end of June (coincides with dramatic decrease in Covid-19 cases). Our checks indicate contractors under our coverage are operational with works gradually ramping up (currently ranges between 40-80% of pre-MCO operating capacity). In our view, broad sector normalisation will be gradual as there are c.450k legal construction foreign workers while Malaysia’s test capacity is 36k (as at end June) though pace of testing should rapidly improve should cases continue to dissipate. Some industry players have also highlighted a complete work pace normalisation (to pre-MCO levels) is not possible as long as SOPs are in-place with 90-95% of pre-MCO operating capacity as the new normal.

Temporary measures act. During the PM’s announcement of PENJANA, Covid-19 Temporary Measures Act (Act) was proposed for tabling in July’s parliamentary sitting. Essentially, the Act aims to mitigate any adverse impact from contractual breaches and enforcement of insolvency actions arising from the pandemic. As part of this initiative, MoW has enforced an automatic EOT of 84 days on all JKR projects with option of further extension (30 days). The Act crystallises contractual relief for contractors. In our view, diversified contractors (with property divisions) are larger beneficiaries as it is likely to include protection clauses for developers and home buyers from penalties arising due to contractual breaches.

No major stimulus projects so far. Under the various PRIHATIN and PENJANA stimulus packages, focus has predominantly centred on smallish infrastructure packages (ie. RM4b for small scale infra works for G1-G4 contractors). The focus on rolling out smaller jobs is in essence due to its lesser degree of complexity (hence faster implementation). It was disclosed that cumulative direct fiscal injection so far is expected to lift fiscal deficit to 5.8-6.0% in 2020, a level still below 6.7% seen in 2009. As such, we see further room for pump priming measures to address the weakening economy. Going forward, sector key events to watch out for are Budget 2021 (Nov 6th) and 12MP (Jan-2021). Outstanding deadlines for HSR (31 Dec 2020) and RTS (31 July 2020) may also present trading opportunities for the sector.

Maintain NEUTRAL. Maintain sector NEUTRAL on construction. In spite of the recent positive mega project news flow, we believe this of largely offset by weaker private jobs outlook (due to weak property market) which has carried the sector since GE14. Key downside risks include: (i) political leadership changes/hung parliament, (ii) resurgence of Covid-19 cases and (iii) margin downside risks (SOP measure, labour constraints, delays)

Top Picks. We continue to like SunCon (BUY, TP: RM2.10) due to (i) strong balance sheet; (ii) extensive track record of infrastructure projects to leverage on pump priming and (iii) strong support from parent-co.

Source: Hong Leong Investment Bank Research - 21 Jul 2020