2Q21 domestic contract awards totalled RM4.0bn (-18% QoQ, +260% YoY). 1H21 featured stronger contributions from water and affordable housing jobs. Phase 1 restrictions should weigh on job flows near term. Sector interest could pick up in 4Q21 spurred by Budget-22, possible 12MP and MRT3 developments. Slash FY21-22 aggregate coverage earnings by -12.7%/-9.7%. Maintain NEUTRAL despite rosy headline DE numbers due to execution risks, weak earnings fundamentals, unpredictable political landscape and stiffer competition for jobs. Key catalysts are 12MP/Budget-22, MRT3 and quick revival in job flows. Downside risks include political fragility as state of emergency lapses and slow project rollout. Our top pick is SunCon (BUY, TP: RM1.87) as a safer choice.

Decent despite circumstance. Domestic contract awards to listed contractors totalled RM4.0bn in 2Q21 (-18% QoQ, +260% YoY). Contracts awarded cooled off sequentially in tandem with stricter Covid-19 restrictions. In 2Q21, job flows were front-loaded as awards since FMCO (1 June) made up only 17% of the entire quarter (based on values) comprising 3 contracts (against 26 contracts awarded in 2Q21). Based on this, a prolonged Phase 1 should weigh on job flows next quarter. On a YTD basis, contracts awarded were higher (+80%) largely due to low base effect as 1H20 saw strict lockdowns imposed. During 1H21, we note stronger contributions from water projects (RM751m) and affordable housing projects (RM1.1bn) which were significantly lower last year. Private building jobs also managed sustain at a normalised rate of RM1.4-1.8bn per quarter.

Notable contracts. Notable contract wins in 2Q21 include (i) Main contractor for J.Satine mixed development project in Setapak to TCS (RM555m), (ii) Pelubang WTP to Bina Darulaman (RM431m) and (iii) high rise affordable homes to Nadi Cergas (RM385m).

Foreign jobs. There was only one foreign contract award this quarter which involved various piling works in Singapore awarded to Pintaras Jaya for a contract sum of RM108m.

Near term lull period. We expect a lull period for sector developments in particular for high impact projects up until the Budget-22 period sometime in 4Q21. The prep for the 12MP is believed to be in its final stages and could feature post Budget 2022 announcement. There should be a pickup in sector interest closer to these events. MRT3 (RM33bn), a high impact project we believe would be part of the government’s economic revival plans is undergoing project reconfiguration, pushing its tenders closer to end 2021 (at the earliest) from Aug-21 previously. The MRT3 carries a larger than anticipated project value (c.30% larger) however, sectorial earnings impact p.a. is roughly 34% lower with double the execution period. A successful vaccination campaign is critical to meeting these expectations as government priorities can only shift towards economic revival once there’s light at the end of the tunnel. The accelerating pace of inoculation (>250k/day) does provide comfort to this end. Apart from this, MyHSR mentioned that a feasibility study for a domestic line is being undertaken. As the economics of the line has significantly shifted, actionable news flow is likely much further down the road. Other mega projects like PTMP (EMP complications) and PBH Sabah (processes) seems to have hit a snag further delaying initial rollout targets. By our estimates, orderbook for stocks under coverage has declined by 17-54% since GE14 necessitating a speedier rollout of new mega projects, which at this point seems to be solely MRT3.

Maintain NEUTRAL. On the whole, we maintain our NEUTRAL weight on the sector despite rosy headline DE numbers under Budget-21 due to execution risks and possible redirection of allocation. We remain cautious on weak earnings fundamentals, unpredictable political landscape and stiffer competition for jobs. Contractors with bigger balance sheet are better positioned for PFI driven projects given constrained fiscal space. The KLCON index trades at a forward P/E of 12.3x (next annuals). Key catalysts: 12MP/Budget-22, MRT3 and quick revival in job flows. Downside risks: political fragility as state of emergency lapses and slow project rollout.

Top Pick. SunCon (BUY, TP: RM1.87) due to (i) strong balance sheet; (ii) extensive track record of infrastructure projects and (iii) strong support from parent-co. The stock is a safer bet considering on-going difficult conditions. The company’s ability to secure overseas contracts provides some comfort should domestic rollout continue to suffer.

Changes in Forecasts and TP

Overall, we have proceeded to slash FY21-22 aggregate coverage earnings by - 12.7%/-9.7%. This is predicated by the enforcement of Phase 1 FMCO in June and curtailing our recovery expectations in-line with the National Recovery Plan. The slash in earnings is driven by: 1) slower site progress; 2) margin markdown 3) delaying/cut new jobs contribution and in some cases cutting wins assumptions.

In deriving our TP, we have rolled forward our valuations to FY22 as we reckon FY21 earnings similar to FY20 is a Covid-19 aberration.

Source: Hong Leong Investment Bank Research - 5 Jul 2021