New public-sector construction project awards remained slow in 2H18 as the government was reviewing ongoing projects to reduce cost. We expect new government contract awards to remain slow in 1H19 but tenders have been called, which will lead to a pick-up in contract awards in 2H19. Aggregate construction core net profit is expected to rebound from a contraction of 11% yoy in 2018 to a growth of 8% yoy in 2019E and 12% yoy in 2020E. We maintain our NEUTRAL weighting on the construction sector. We prefer small and mid-sized pure-play contractors for exposure to the sector. Our top BUYs are Sunway Construction (SCGB), Gabungan AQRS and HSS Engineers.

Review of Major Contracts Completed

The government’s review of public-sector projects awarded in the past to reduce cost continues. But we understand that the renegotiation of contract prices for major infrastructure projects, such as Klang Valley Mass Rapid Transit Line 2 (MRT2), Light Rail Transit Line 3 (LRT3) and Pan Borneo Highway (PBH) Sarawak, have been completed for the main contractors. The review led to slow progress on certain projects such as the LRT3 due to a major re-design and cut in scope of works. As a result, aggregate construction core net profit declined 37% yoy in 4Q18 due to slower progress billings. Construction companies with substantial contributions from other divisions such as property, plantation and concrete products were also adversely impacted by the weak conditions in these industries.

Government Spending to Pick Up in 2H19

The Malaysian government’s development expenditure contracted 19% yoy to RM7.6bn in 3Q18, the lowest quarterly disbursement since 3Q15. We believe this reflects the effects of a change in government and the project reviews. We expect government contract awards to pick up in 2H19 as tenders are being called in 1H19. We gather that the projects to be implemented comprise government hospitals, schools, roads, railway and water supply/distribution. Most of the contract values are likely to be smaller given the nature of the projects and the open-tender basis of awards. Hence, we believe the small to mid-sized contractors and engineering consultants (pure plays) will see more significant benefits from these projects compared to the large construction conglomerates with diversified operations.

Sarawak to Accelerate Infrastructure Spending

The Sarawak government is expected to award contract packages for the RM5bn Coastal Highway, RM6bn Second Trunk Road and RM8bn Water Grid Phase 1 in 1H19. We believe Sarawak-based contractors and construction material suppliers such as Cahya Mata Sarawak (N-R), Hock Seng Lee (NR) and KKB Engineering (N-R) are potential beneficiaries. However, we believe the Sarawak government could face financial constraints to implement all these projects simultaneously, given the challenge to issue bonds or utilise its reserves of over RM30bn, without affecting its credit ratings on existing bonds guaranteed by the state government. Hence, the implementation of the projects is likely to be on a staggered basis. We gather that there are also many contractors bidding for the projects including Peninsular Malaysia-based contractors partnering with local Sarawak contractors and competition is stiff for the work packages.

Source: Affin Hwang Research - 8 Mar 2019