Robust Outlook Despite Non-construction Drag

The 2Q17 results for the Construction Sector were generally below expectations. Strong earnings growth for the companies’ construction divisions was held back by weaker earnings for their non-construction businesses. However, the sector charted strong aggregate core EPS growth of 9% qoq and 23% yoy in 2Q17. We remain Overweight on the sector on the positive outlook on contract awards, which should accelerate in 2H17 with major packages for LRT Line 3 rolling out. Our top BUYs are Gamuda, WCT and HSS.

Strong Sector Core Earnings Growth in 2Q17

The construction sector’s aggregate core EPS grew 23% yoy in 2Q17, the fourth consecutive quarter of positive growth and accelerating from 6% yoy in 1Q17. This was mainly driven by higher construction earnings as progress billings accelerated on new construction contracts secured last year. The property divisions for the companies under our coverage, such as Gamuda, IJM Corp, WCT, MRCB and AQRS, saw weaker earnings. Suncon saw weaker earnings from its precast concrete division due to a lower sales volume as construction progress for a main contractor slowed.

LRT3 Contract Awards Likely to Accelerate

We expect contract awards to accelerate in 2H17 as major packages of Light Rail Transit Line 3 (LRT3) project are rolled out. To date, RM3.4bn worth of contracts have been awarded for the LRT3 project and indications are the total contract value could exceed the initial estimate of RM10bn. WCT and TRC Synergy won LRT3 packages of RM1.03bn and RM0.76bn respectively. We believe the remaining packages will be awarded by early October. Other contractors vying for the remaining packages should include Gamuda, IJM Corp, Suncon, AQRS, Mudajaya, Fajarbaru, Gadang and unlisted Syarikat Muhibbah (AQRS’ Bumiputera partner).

Higher Development Expenditure for Budget 2018

We believe the government will increase the allocation for development expenditure in the upcoming Budget 2018 to be announced on 27 October 2017. We forecast the development expenditure budget to increase to RM50bn in 2018 compared to RM46bn in 2017 to meet the RM260bn target spending in 2016-2020 under the 11th Malaysia Plan (11MP). This augurs well for the construction sector with more public sector projects.

Remain Overweight

We are Overweight the construction sector as news flow on contract awards should sustain sector outperformance in 2H17. The award of subcontract works for the RM55bn East Coast Rail Link (ECRL) project is expected to start in 4Q17. We see more value in small/mid-cap names like WCT and HSS. In large caps, we prefer Gamuda over IJM. Risks: project delays and rising construction costs.

Source: Affin Hwang Research - 11 Sept 2017