We maintain OVERWEIGHT on the construction sector. Assuming a market-friendly outcome of the state elections on 12 Aug 2023, we expect an acceleration in the rollout of the RM45b MRT3 project and six flood mitigation projects reportedly to be worth RM13b, and the disbursement of the massive RM97b gross development expenditure budgeted under Budget 2023 (+35% YoY vs. RM71.6b a year ago). Meanwhile, the private sector construction market is vibrant underpinned by massive investment in new semiconductor foundries and data centres. Our top picks are GAMUDA (OP; TP: RM5.15) and SUNCON (OP; TP: RM2.13) as we believe they will extend their winning streaks for new jobs.

Flood mitigation projects and MRT3 to revitalise the sector. Assuming a market-friendly outcome of the state elections on 12 Aug 2023, we expect an acceleration in the rollout of the RM45b MRT3 project and six flood mitigation projects reportedly to be worth RM13b including flood mitigation works at Sungai Johor (Johor), the construction of the Sungai Klang-Sungai Rasau dual-function reservoir (Selangor) and the Sungai Golok Integrated River Basin Development Phase 3 (Kelantan). There will also be an accelerated disbursement of the massive RM97b gross development expenditure budgeted under Budget 2023 (+35% YoY vs. RM71.6b a year ago). Already, AZRB (Not Rated) secured RM122.5m road works in Cameron Highlands in early June.

MRT3 work package awards in the works. We understand that MRT Corp had sought the consent from the tenderers of MRT3 work packages to extend the validity of their bids by three months to 30 Sep 2023 (from 30h Jun 2023). This goes to show that MRT Corp is actively implementing the project, although it needs to undertake more thorough scrutiny on its design, specifications, alignment and funding mechanism.

Meantime, the government has agreed to fund the proposed Penang LRT in return for the Penang South Island (PSI) project being scaled down. We believe this is positive to the sector as the project could potentially get off the ground sooner as it is no longer constrained by the availability of profits and cash flows from PSI.

For on-going projects in East Malaysia such as Pan Borneo and Sabah Sarawak Link Road, the government has earlier provided commitment to accelerate and expedite these projects. IJM (MP; TP: 1.67) has indicated keen interest to channel its resources to tap into this area.

The private sector job market is expected to continue growing as multinational corporations (MNCs) diversify their manufacturing bases away from China to mitigate risks. This shift has created new opportunities in the construction sector, particularly in the establishment of semiconductor plants and data centres. These projects come with larger contract sizes (ranging between RM1 billion to RM1.5 billion each) and a much shorter timeline versus conventional contracts – enabling contractors to command a premium. Notably, companies like SUNCON and KERJAYA (OP; TP: RM1.50) have already benefited from such contracts in CY22.

The outstanding order book levels are projected to improve in CY23. As the public job market has been sluggish in CY22, some contractors heavily reliant on public projects, such as IJM and WCT (OP; TP: RM0.60), have depleted their order books beyond their replenishment capacity. As a result, order book levels have hit a 4-year low. However, with the anticipated rollout of public jobs mentioned earlier, we expect these contractors to experience an improvement in their order book levels in CY23.

The sector dynamics are favourable for earnings growth in CY23. We anticipate several factors contributing to improved earnings prospects. Firstly, the gradual return of foreign workers will alleviate labour shortages. Additionally, the lower prices of base metals like steel and aluminium, along with other key building materials such as diesel and bitumen due to weaker oil prices, will positively reduce costs. Furthermore, most new contracts currently under negotiation will incorporate the latest higher prices and include provisions for price variation to protect margins in case of significant swings in material prices. As a result, overall margins should gradually improve as older low-margin projects are phased out and replaced by new projects adjusted for higher input costs.

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 picks for the sector are:

(1) GAMUDA given: (i) it being the front-runner for the tunnelling job for MRT3, (ii) its competitiveness in securing new jobs within 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 RM21.5b, and (v) its efforts to expedite growth in the renewable energy space in line with global sustainability goals.

(2) SUNCON for: (i) its consistent replenishment pipeline from parent SUNWAY (OP; TP: RM2.15), (ii) its dominant position in the local construction space with extensive capabilities and track record in building, infrastructure, solar, mechanical, electrical and plumbing works, (iii) its strong balance sheet that allows it to participate in deferred payment model projects and (iv) its all-time high outstanding orderbook of RM12.3b alluding towards strong earnings growth in the immediate term.

Source: Kenanga Research - 3 Aug 2023