We maintain OVERWEIGHT as we believe the sector will benefit from the rollout of public infrastructure projects, spearheaded by the massive RM50.2b circle metro line MRT3 project, as the new government gets down to work. There is also a strong case for the government to embark on counter-cyclical fiscal pump-priming to shield the economy from the external slowdown. In the private space, a new wave of investment in semiconductor foundries and data centres by MNCs in Malaysia has been a shot in the arm for local contractors. Meanwhile, headwinds in terms of labour shortage and spikes in construction material costs are dissipating. Our top pick for the sector is GAMUDA (OP; TP: RM5.15).

Public projects put under review for transparency. We expect the new government to re-tender selective public infrastructure projects and roll out new ones, after completing reviews on certain previous job awards that were deemed not in compliance with the required procurement process. A case in point is the RM15b flood mitigation project which was purportedly awarded through direct negotiation. For on-going projects such as Pan Borneo, Sabah Sarawak Link Road, Central Spine Road and ECRL, the indication thus far has been that the government will not turn off the tap and they will go ahead as per original plans. We believe that there is a strong case for the government to embark on counter-cyclical fiscal pump-priming to shield the economy from external slowdown with high-impact projects such as the MRT3 project.

Opportunities in the private space too. On the private sector front, there are growing opportunities in the construction of new semi-conductor plants and data centres locally as MNCs diversify their manufacturing bases geographically (away from China) to de-risk. These contracts generally command better margins than the conventional building jobs as they are fast-track and technically more demanding. So far, contractors under our coverage including KERJAYA (OP; TP: RM1.50), IJM (MP; TP: RM1.68) and KIMLUN (OP; TP: RM1.12) have already bagged such jobs in Penang and Melaka while SUNCON (OP; TP: RM1.60) is actively bidding. Meanwhile, the same cannot be said for the office and high-rise residential segments given the persistent oversupply.

Headwinds dissipating. We believe operationally the sector had already saw the worst in 2022 and should be poised for a better operating environment in 2023 given the gradual return of foreign workers and the easing prices of construction materials. Since Jun 2022, prices of key construction materials such as steel and aluminium have come off substantially due to the slowdown in China. So have prices of diesel and bitumen on the back of weaker oil prices. Nonetheless, prices of cement and concrete have remained elevated while the increased benefits to employees with amendments to the Employment Act coming into effect on 1 Jan 2023 will mean higher labour cost to contractors.

That said, most recently awarded contracts would have reflected the higher cost of construction materials. Also, in the aftermath of the recent input cost shock, it has become more common for contracts to carry a price variation clause to protect margins of contractors. We expect industry margins to improve in 2023 as older contracts with low margins tail off and new contracts with more normalised margins start to contribute.

Our top pick for the sector is GAMUDA given: (i) its strong chances of emerging as the tunnelling contractor for MRT3, (ii) its recent job wins in in Australia and Singapore that speak eloquently for its competitiveness in the international market, and (iii) strong balance sheet which puts it in a strong position to participate in public infrastructure projects on a PFI or deferred payment model. Maintain OVERWEIGHT on the sector.

Source: Kenanga Research - 12 Dec 2022