The construction stocks have seen volatile price movements due to the ongoing reviews of large-scale projects. It was reported that the East Coast Rail Link (ECRL) project could be scaled down to RM40bn from RM55bn. Slow order-book replenishment is expected for the local contractors for at least the next 12 months. However, large order books, equivalent to over 3x historical construction revenue, will likely sustain sector core EPS growth of 19% yoy in CY18E and 15% yoy in CY19E. Maintain our NEUTRAL sector call. Top BUYs are IJM, Suncon and HSS.

Scale Down, Cancel or Postpone?

The ongoing reviews of public-sector infrastructure projects have raised uncertainties on the status of ongoing and planned infrastructure projects. This has led to volatility in the share prices of the construction stocks. Prime Minister Tun Dr. Mahathir Mohammad said that the Kuala LumpurSingapore High Speed Rail (HSR) project has been postponed, and not scrapped as stated previously, leading to a relief rally for impacted firms.

Positive If Infrastructure Spending Cuts Are Not as Severe

These developments indicate that the infrastructure spending cuts may not be as severe as initially portrayed in statements made by the new government previously. We believe part of the reason is due to costly cancellation clauses in government-to-government contracts signed for the ECRL and HSR. If the HSR is revived, companies involved such as Gamuda (HOLD), MRCB (BUY), YTL Corp (YTL MK, RM1.06, HOLD) and HSS (BUY) are potential beneficiaries. If construction of the ECRL project continues, Malaysian contractors pursuing subcontracts such as IJM Corp (BUY), WCT (HOLD), and Advancecon (Not Rated) are potential beneficiaries. The cancellation risk for HSS’ ECRL contracts, worth about RM130m (19% of its order book of RM673m), is also reduced.

Cautious Foreign Investor Feedback

There was good investor interest in our recent macroeconomics/construction sector outlook analyst meetings. We met up with 23 foreign institutional investor firms in Singapore and Hong Kong. Most investors were concerned with the short-term impact from the transition to a new government but acknowledged the good long-term prospects of a more transparent and efficient government.

Maintain Our NEUTRAL Call

We reiterate our NEUTRAL call on the Construction sector due to potential delays in implementation of infrastructure projects and the reduction in government infrastructure spending. This will reduce the order-book replenishment prospects of contractors. Our top BUYs are IJM (large-cap), Suncon (mid-cap) and HSS (small-cap).

Source: Affin Hwang Research - 14 Jun 2018