We believe prospects for the construction companies to replenish their order books will remain challenging in 2020. Rising risks of an economic slowdown and a tighter federal government budget could lead to a cut in development expenditure. The change in government could lead to delays in the award of public-sector projects due to policy reviews and reprioritising of projects. We stay UNDERWEIGHT the sector and downgrade IJM Corp to SELL from Hold and AQRS to HOLD from Buy. Top sector BUYs remain SunCon, AME and Taliworks. We now have SELL calls on Gamuda, IJM Corp and MRCB.

Risk of Reduced Infrastructure Spending

The World Health Organization’s declaration of the Covid-19 virus outbreak as a pandemic highlights the risk of a global economic slowdown due to supply-chain disruptions and weak demand for goods and services. As an open economy, Malaysia will be adversely impacted and could see a real GDP growth slowdown to the low end of the official government forecast range of 3.2-4.2% in 2020E. The sharp fall in the Brent oil price will reduce the federal government’s revenue from oil-related sources, which contribute about 30.8% of total revenue. The government may reduce development expenditure to mitigate the impact on the federal government deficit, which could lead to lower infrastructure spending.

Construction Sector Earnings Cuts

We expect lower infrastructure spending in 2020 as implementation of new large-scale projects could be deferred. We cut our earnings forecasts for construction companies under our coverage to reflect lower assumptions of new contract wins and weaker property sales. As a result, we now expect sector core EPS to grow 2% yoy in 2020E and contract 5% in 2021E. The loss of toll highway earnings for Gamuda contributes to the sector EPS decline in 2021E (assumes the disposal of its toll highway concessions at end-FY20). Our sector 2020E core EPS growth was 13% yoy in early-2020 and 8% yoy before this round of earnings cuts. Our sector 2021E core EPS growth was 4% yoy before this round of earnings cuts.

Reduced Target Prices for Construction Stocks

We reduce the target prices for most construction stocks under coverage to reflect lower RNAV estimates and higher discounts to RNAV to derive target prices for some stocks. Construction sector average share price discounts to RNAV over the past 4-5 years were in the range of 8-47%. Share price discounts to RNAV were at the widest during periods of political and federal government deficit concerns in 2015 (1MDB issue) and 2018 (14th General Election saw a change in government). Given the “perfect storm” concerns currently, we believe wider discounts to RNAV are warranted to derive our target prices for some stocks that historically traded at wider discounts such as IJM, MRCB and WCT.

Maintain Our UNDERWEIGHT Sector Call

We stay UNDERWEIGHT the sector. We downgrade IJM to a SELL from Hold with a reduced TP of RM1.58, based on a wider 30% discount to our lowered RNAV. We cut our core EPS forecasts by 16% in FY21-22E to reflect lower CPO price assumptions and lower new construction contract wins. We downgrade AQRS to HOLD from Buy with a lower TP of RM1.10, based on the same 20% discount to reduced RNAV. Sector top BUYs are SunCon, AME and Taliworks.

Previous Minister of Works Returns

Datuk Seri Fadillah Yusof was appointed as Minister of Works under the new government formed by Perikatan Nasional. He was the Works Minister prior to the change in government led by Pakatan Harapan in May 2018 and hence has the experience to hit the ground running. But it is uncertain if he will review policies on the award of new public-sector contracts adopted by the previous government and re-prioritise projects to be implemented, which could cause delays in contract awards.

Some Positive Indications of Policy Consistency

Fadillah said that the Pan Borneo Highway will continue through the use of a conventional project approach following the termination of the Project Delivery Partner by the previous government. We view this positively as changing the implementation approach again would cause further delays in completing the project. The appointment of a technocrat, ie, former CIMB CEO Tengku Dato’ Sri Zafrul Aziz, as Minister of Finance is a welcome change if he is able to improve transparency and efficiency in the disbursement of the government’s development expenditure.

Earnings Cuts

Following a review of earnings forecasts for the construction companies in our universe, we have revised down most of our estimates. This is to reflect lower new contract wins due to lower government infrastructure spending expected and weaker property sales. Our upgrade of Gamuda’s core EPS in FY20E is to reflect the potential delay in the sale of its toll highway stakes to end-FY20 (additional 5-month contribution to group earnings). But we cut its FY21-22E forecasts assuming delays in securing new contracts such as the Penang Transport Master Plan and Klang Valley MRT Line 3 in FY22 instead of FY21.

Lower RNAV and Target Prices

We reduce our RNAV estimates for some of the companies to reflect (1) lower construction PER valuations of 12-15x (reduced from 12-16x) and sustainable earnings; (2) higher WACC for concession and property DCF valuations (raised equity risk premium from 6% to 7%); and (3) weaker property sales. In deriving our new TPs, we applied high discounts to RNAV for IJM (raised to 30% from 20%), MRCB (raised to 50% from 40%) and WCT (raised to 60% from 50%) considering the relatively high historical average and peak discount levels during periods of economic and political uncertainties.

Source: Affin Hwang Research - 13 Mar 2020