MRCB has set ambitious long term ESG goals, looking to achieve carbon neutrality by 2040 starting with cutting energy intensity ratios by 1% come 2022. To achieve this, MRCB has revamped its governance and incentives structure. Nevertheless, we do note several sector related challenges which are likely medium term sticky as highlighted below. The company stands out as the only FTSE4Good Index constituent in our sector coverage. Maintain HOLD with unchanged TP of RM0.43. Our TP implies a FY21/22/23 P/E multiple of 123.9x/26.8x/25.5x.

We Assess MRCB From An ESG Perspective With the Following Key Takeaways:

Adherence to key standards and policies. In its sustainability journey, MRCB aligns itself to 12 out of 17 United Nations Sustainable Development Goals (UN SDG). MRCB has adopted and applied the statutory requirements, principles and best practices as set out by Bursa Malaysia, Malaysia Code of Corporate Governance (MCCG) in addition to being benchmarked against the ASEAN corporate governance scorecard. In tandem with this, MRCB practices Code of Business Ethics, Whistleblowing policy, No Gift policy and Anti Bribery and Corruption policy. In 2018, MRCB engaged independent consultant, Transparency International for an Anti Bribery audit and have since implemented procedures to fix gaps identified.

Governance structure to monitor execution. In order to implement sustainability measures, MRCB has established a dedicated governance structure. At the core is its sustainability management committee charged with: 1) ensuring objectives are met, 2) reviewing effectiveness of initiatives and 3) make recommendations to the Board on material sustainability issues. Management is in the process of incorporating sustainability KPIs into performance review which should incentivise the transition to achieve its long term ESG goals.

Addressing carbon emissions. According to IEA, building and construction industries are key contributors to carbon emissions (39% share) playing a part in increasing global carbon footprint. Of this 39% share, 28% is related to building operational emissions during the asset’s lifecycle with the remaining 11% being emitted during the construction phase (including materials). Moving forward, the proliferation of green financing and greenwashing trends could penalise the sector and its supply chain as “ESG spread” is built in to the cost of doing business. We reckon this may paradoxically impact social factors as incremental costs are eventually passed on resulting in lower housing affordability and higher infrastructure development costs, compounding the gap between developing vs developed countries. In addressing the above concerns, MRCB is aiming to reduce its carbon, energy, waste and water intensity by 1% come 2022 and strives towards carbon neutrality by 2040 (key parameters outlined in Fig 3). To aid this pathway, MRCB has developed 5 and 10 year roadmaps as an internal guide. Given the nature of construction supply chain, MRCB would have to rely on offset initiatives in achieving its carbon neutral goal, in our view. In the mean-time, environmental initiatives are still young and tangible improvements would require a gestation period.

Gender equality. Looking at the gender divide, MRCB’s average gender pay gap is 3.5% comparing favourably with national average of 29.1%. In terms of workforce, females comprise of 38% falling roughly in-line with Malaysia’s labour force composition. We consider this to be an achievement as talent pool in the construction sector is usually male dominant. However, this does not extend to its BOD with only 1 female representative on the board. We note that its previous board composition saw female representation at c.30% (consistent with best practice) but recent reshuffling due to retirements has brought about this change.

Foreign labour. All hiring is done by appointed recruitment agencies via tender or invitation based on their past track records. MRCB strictly adheres to the procedures and relevant regulations involved in hiring foreign labour. MRCB ensures the provision of Centralised Living Quarters (CLQ) and other welfare facilities at its project sites and is in full compliance with Workers' Minimum Standards of Housing and Amenities (Amendment) Act 2019 (Act 446), enforced by the government in September 2020. To address excessive dependence on foreign labour over the longer term, the company will increase the usage of modular construction which is beneficial to: (1) reduce construction labour requirements by 30%, (2) reduce noise, dust & other forms of pollution and (3) lowering work defects. Such a move is in keeping with government’s long term plan to reduce foreign worker dependence to 15% disclosed in the recently announced 12MP. Despite best efforts, we think foreign worker dependence is a sticking point as the sector faces structural difficulties in attracting local labour due to its “3D” tag (Dirty, Dangerous and Difficult). This is further exacerbated by a long term trend of increasing societal affluence in Malaysia.

Community programmes. The company runs an equal opportunity employment program, PEKA@MRCB which provides employment opportunities to prison inmates and aims to absorb them upon release. Around 156 inmates have joined the program since its launch in 2019. During this pandemic, MRCB has donated RM1.5m in the form of food baskets, PPE and other essentials to various vulnerable groups. Its Covid-19 community relief contributions are noticeably better than some sector peers we cover.

Board composition. Looking at its board composition, Independent Directors (ID) constitutes 3/8, a ratio slightly below MCCG’s best practice of 50%. Directors’ backgrounds are also reasonably diverse with 5 from financial sector, 2 from property & construction and 1 from resource fields respectively. Management is seeking to increase board representation from within its industry which we believe could be tricky given challenges imposed by best practice ID composition (>50%) and competitive reasons. We note MRCB’s Independent Non-Executive Chairman has served on the board since 2005 and in 2018 was re-designated as Independent from Non Independent. In assessing independence, MRCB engages KPMG and the above re designation was also put out to a two-tier voting process prior to implementation. To put things in fairer context, according to SC (up to Mar-2021), 434 IDs have served more than 12 years with 49 serving beyond 20 years in Malaysia, therefore such practices are not uncommon for Corporate Malaysia. Nonetheless, Bursa’s recent proposed amendments to limit IDs to a cumulative 12 year limit (board tenure) may require some changes on MRCB’s part (proposal is ongoing).

Remuneration & fees. Since peak revenue in 2017, BOD compensation has declined roughly in tandem with revenue at -64% and -58% respectively. We believe this indicates remuneration policy in-line with performance expectations. During the pandemic, MRCB implemented a 30% voluntary pay cut for its board and senior management while maintaining salaries for remaining employees. Another trend of improvement is also the declining share for non-audit fees paid to its auditor, PWC from 64% in 2016 to 17% in 2020 which is beneficial to audit objectivity perception.

Risks to FTSE4GOOD status. MRCB has consistently maintained its position in the index over the past three years with scores improving from 1.7 to 2.7 in 2020. Within our sector coverage, MRCB is a standard bearer being the only stock included as a constituent. Nevertheless, this could be due to its classification as a property counter under FTSE as we note construction stocks are absent from the index. We gather from management that assessment methodology has shifted with stricter required thresholds on environmental aspects which could weigh on construction/property companies in general, including MRCB for reasons highlighted above.

Maintain HOLD, TP: RM0.43. Maintain HOLD with an unchanged SOP-driven TP of RM0.43. Our TP implies a FY22/23 P/E multiple of 26.8x/25.5x. The stock lacks catalysts beyond the reopening and weak execution may pose a continued drag on near term performance while its low P/B trading multiple of 0.40x might cushion further downside. Catalysts: MRT3 rollout; Downside risks: Covid-19 setbacks, political uncertainties and materials cost pressure.

Source: Hong Leong Investment Bank Research - 21 Oct 2021