We maintain OVERWEIGHT for the sector premised on better order book replenishment and earnings prospects in CY23. The 4QCY22 results for companies in our coverage universe were flat against last quarter. The margins realised by most contractors in CY22 were still below pre-Covid levels due to labour shortages and the soaring cost of building materials, particularly steel. However, we believe the sector has seen the worst and should be poised for improved earnings in CY23 given the gradual return of foreign workers and recent easing in base metal prices. We also foresee better job replenishment prospects with the imminent rollout of MRT3 and Pan Borneo Highway (Phase 2), plant expansion in the semi-conductor space as well as the proliferation of new data centres. Our top pick for the sector is GAMUDA (OP; TP: RM5.15) given it being the front-runner for the tunnelling job for MRT3, its recent job wins in Australia and Singapore, as well as a strong war chest after the disposal of its toll highways.

A flat performance. Construction counters under our coverage saw unchanged sequential performance in 4QCY22 earnings with 33% and 67% coming in above and within our forecasts, respectively. SUNCON (OP; TP: RM2.13) came above expectation on lumpy fourth quarter performance derived from cost savings for projects nearing completion while KIMLUN (OP; TP: RM1.12) outperformed thanks to positive tax returns.

Margins still below pre-Covid levels. The margins realised by most contractors in CY22 were still below the pre-Covid levels due to the soaring cost of building materials, particularly steel, cement, and labour shortages that hampered work progress. GAMUDA and SUNCON are the only exceptions which saw construction margins being stronger than pre-Covid levels due to cost savings from projects nearing completion.

Mixed outstanding order book levels. Amidst a slow public job market in Malaysia for CY22, IJM (MP; TP: RM1.70) and WCT (OP; TP: RM0.60) have experienced drawdown exceeding replenishment in their order books, depleting the outstanding order book further to a 4-year low. Nonetheless, GAMUDA, SUNCON and KERJAYA (OP; TP: RM1.50) managed to lift their outstanding order books to record high levels thanks to geographical diversification and penetration into new building jobs such as data centres and semiconductor factories.

CY23 to be better. With an all-time high development expenditure allocation in the revised 2023 National Budget, we foresee better job replenishment prospects coupled with the imminent rollout of MRT3 and Pan Borneo Highway (Phase 2). Meanwhile, as MNCs diversify their manufacturing bases geographically (away from China) to de-risk, there are opportunities in the construction of new semi-conductor plants and data centres locally where the contract sizes are relatively larger, ranging between RM1b to RM1.5b each.

We believe earnings prospects should improve in CY23 given the gradual return of foreign workers and the lower base metal prices (steel and aluminium) and other key building material prices such as diesel and bitumen on the back of weaker oil prices. Meanwhile, most new contracts currently under negotiation would incorporate the latest prices (which are higher) and also with an element of price variation built in - to protect margins in the event of huge swing in material prices. Hence, we believe overall margins should gradually improve as the older low-margin jobs trail off and replaced by new projects adjusted for higher input costs kick in.

Reiterate OVERWEIGHT. Aside from the better earnings trajectory projected, we believe a sector re-rating is in the making on expectation of awards of public infrastructure jobs after a long drought. Our top pick for the sector is GAMUDA given: (i) it being the front-runner for the tunnelling job for MRT3, (ii) its job wins in in Australia and Singapore that speak eloquently for its competitiveness in the international market, (iii) its strong war chest after the disposal of its toll highways, (iv) its strong earnings visibility underpinned by a record high outstanding order book of RM22b, and (v) its efforts to expedite growth in the renewable energy space in line with global sustainability goals.

Source: Kenanga Research - 15 Mar 2023