Investors will be turning to Sarawak for potential catalysts in the construction sector. This comes as the Sarawak state government has big plans to roll out major infrastructure projects to stimulate economic activity while on the other hand, the new Federal government may want to review the pipeline of construction jobs previously touted to be revived (such as PTMP, MRT3, HSR and RTS) as part of its revamped growth strategy. It will probably take some time for the dust to settle as the new government gets down to work before any key policy announcements are made.

With share prices likely to remain volatile reflecting the uncertain sector backdrop, we have scaled back our PE multiples (pegged at -1.5SD to mean valuations) to derive revised target prices for construction stocks under our coverage. In comparison, the construction sector was trading at a range of -2SD to -1SD below mean PEs for almost nine months after GE14.

We are keeping our Neutral sector call. At current levels, our top sector pick for large cap is Gamuda (OP; TP RM3.70) while HSL (OP; TP RM1.69) is our choice for exposure to the rising construction activity in Sarawak. Separately, our analysis of the past 3 state elections shows there is no obvious correlation with the performance of Sarawak-related stocks except for a few names.

Look East strategy. Investors will shift their focus to Sarawak in search of good news for the construction sector. This comes as there may be fewer sizeable job opportunities in Peninsular Malaysia for the time being as the new Federal government may want to review the pipeline of projects (which we will discuss more below). On the other hand, Sarawak has unveiled the state budget with plans to spend RM22b on infrastructure projects including the Second Trunk Road (RM6b), coastal road upgrades (RM5b), water grid programs (RM2.8b), rural electrification projects (RM2.4b) and telco towers (RM1b).

Gearing up for state elections. Timing-wise, it would probably make political sense to roll out these projects to stimulate economic activity ahead of the Sarawak state election, which must be held by Sep 2021. The current state government is helmed by the ruling coalition Gabungan Parti Sarawak (GPS), a friendly party to the Perikatan Nasional-controlled Federal government. In the last state elections in 2016, GPS together with other component parties in the then ruling Barisan Nasional coalition won 72 of the 82 state seats to secure a comfortable margin of victory.

Sarawak election plays - a peek into the past. To gauge possible share price effects arising from the state elections, we refer to the past three polls to analyse the performance of a basket of Sarawak-based companies across various time periods. In conclusion, there is no visible historical pattern for the individual stock’s performance in the run-up to election day. Indeed, the probability of our list of 16 Sarawak-related companies posting positive returns across the six holding periods were less than 50% in most cases (Appendix 1a, 2a, 3a). What has been obvious too is that the closer to polling day, the overall returns turned out to be more mixed, possibly swayed by election outcome jitters. In our analysis, the most profitable investment period was 6 months leading to election date, with average returns of 6.3% in 2006, 7.6% in 2011 and 2.6% in 2016. Perhaps a better alternative is to analyse each stock individually (instead of lumping all of them in one basket) as their share prices would have been driven by their respective stock fundamentals. Our key takeaways (from Appendix 1b, 2b, 3b) indicate that: (i) in 2011, only Bintulu Port showed positive returns for all time periods with an average return of 2.9%, and (ii) in 2016, Quality Concrete (average return of 8.2%) and Sarawak Plantation (average return of 4.1%) were up for all the time spans while Bintulu Port (average return of 1.8%) and Kim Hin (average return of 0.7%) registered gains in five of the six time periods. To complete our analysis, we have also tabulated the performance comparisons of the stocks post elections in these tables and compiled a snapshot of their financials and valuation parameters (Appendix 4).

Mega infrastructure projects under review? Meanwhile, it remains to be seen whether the new Federal government (like its predecessor) will review existing and new major construction projects initially after they take office. Among the high-profile infrastructure projects that have been earmarked to be revived include: (i) the RM3.2b Johor Bahru-Singapore Rail Transit System (RTS) with the finalisation of contract terms previously scheduled to be in April this year, (ii) the ~RM60b Kuala Lumpur Singapore High Speed Rail (HSR), which is supposed to be revisited by both countries in May 2020, (iii) the ~RM40b Mass Rapid Transit 3 (MRT3), earlier speculated to be considered for revival in the later part of this year, and (iv) the RM32b Penang Transport Master Plan (PTMP), with the project delivery partner or PDP agreement originally to be inked in 1QCY20 following the previous Federal government’s green light to guarantee the bond financing for the LRT component.

Regarding the PTMP, Gamuda will likely be the most affected as the company – which via its 60%-owned SRS Consortium was on the verge of sealing the deal – may not be able to kick off the project as per the initial timeline of second half of 2020. Its proposed sale of four highways for an equity value of RM2.36b (or 95.0 sen per Gamuda share, part of which was to be distributed as special dividends to its shareholders) is also in doubt now following the change in government. Nonetheless, beyond the initial transition period, when the new Federal government hits the ground running, Gamuda could be well-positioned (given its past track record) to re-visit mega infrastructure jobs such as MRT3 and HSR with the new administration.

Sector call is NEUTRAL. To factor in the prospect of fewer major construction job opportunities in the near term, against the uncertain backdrop, we have attached lower PE multiples – at minus 1.5 standard deviation (SD) to mean valuations – for construction stocks under our coverage. This is slightly above the valuation levels of construction stocks post the 14th General Election (14GE) in May 2018 when the KLSE Construction Index treaded between -2SD to -1SD below its 3-year mean for nearly nine months (Chart 1), as we take a view that the prevailing cloud of uncertainties will probably come to a pass sooner than the post-GE14 experience. Our revised stock ratings and target prices are shown in the table below. At the current price levels, our top sector pick for big cap is Gamuda (OP; TP RM3.70). Meanwhile, HSL (OP; TP RM1.69) is our selection for exposure to the rising construction activity in Sarawak.

Source: Kenanga Research - 11 Mar 2020