Despite the multiple setbacks, we keep our OVERWEIGHT call for the sector, underpinned by vaccination efforts which will eventually prime the sector for a re-opening play. That said, the longer the Covid-19 pandemic drags out, the lower our conviction for the sector is. This is due to the weaker fiscal position which would either mean (i) slower roll-out of projects, (ii) smaller quantum contracts or (iii) a higher reliance of PFI funding from contractors’ balance sheet. Consequent to this, we dial down our ascribed valuations for contractors under our coverage. Notable downgrades are Suncon (MP; TP: RM1.60) and HSL (MP; TP: RM0.95). We are now more selective with our picks where we prefer counters that have a predictable set of catalysts, robust execution track record and earnings delivery capabilities such as Gamuda, Kerjaya and Kimlun.

FMCO cast further earnings and replenishment risks. With the FMCO halting most construction works with exception to certain works which are allowed to operate at a maximum 60% capacity; we foresee further earnings risks for contractors for the remainder of the year. In the table below, we lower our earnings and replenishment estimates for contractors of which we have not adjusted for the FMCO impact. Compared against consensus, we believe they have yet to adjust their estimates downwards.

Expectation of contract roll-outs has been muted. In tandem with the slower-than-expected recovery, contract roll-outs have been muted with little developments over key infrastructure projects. Most of our key anticipations at the start of the year have yet to pan out as tabled below.

A weaker fiscal position does not bode well with the sector. Since the pandemic started in March 2020, the government has directly injected c.RM81b for all Covid-19 assistance packages. As a comparison, FY2021’s budgeted Devex (development expenditure) was RM66b in which we think that some of these funds could possibly be diverted to fund on-going assistance packages announced during the FMCO (ie PEMERKASA+, PEMULIH). Based on our in-house projections, the Federal government would hit a debt to GDP ratio of 64.8% by year-end – above the statutory ceiling level of 60%. Consequent to a weaker fiscal balance sheet, we think future projects being dished out by the government could (i) see a slower rollout, (ii) be smaller in quantum or (iii) be more reliant on contractors utilising their balance sheet for funding i.e. PFI. We believe such scenarios are less market friendly. Hence, the longer the Covid-19 pandemic drags out, our conviction for the sector wanes.

Dial down valuations. In light of the weaker fiscal position which could impact the future roll-out of contracts, we choose to dial down valuations for contractors under our coverage. The updated TP and calls for contractors are tabled below. Key rating changes are the downgrades of Suncon and HSL to Market Perform (from Outperform). We think that Suncon’s profitability in the immediate term would be weighed down by a slow recovery in India which currently makes up 17% of their outstanding RM5b order-book. Meanwhile, our downgrade for HSL is mainly due to the illiquidity of its shares coupled with the lack of catalysts.

Still an OVERWEIGHT but more selective on picks. Despite the setback from the lockdowns, we still believe construction is one of the key sectors to benefit from an imminent re-opening play as the nation’s vaccination rate accelerates. That said, we prefer counters that have a predictable set of catalysts lined up coupled with robust execution and earnings delivery capabilities. These names include Gamuda, Kerjaya and Kimlun. That said, we note that our recovery thesis hinges over our nation’s rate of Covid-19 recovery.

Source: Kenanga Research - 1 Jul 2021