Kenanga Research & Investment

Construction - Appetite for Construction

Publish date: Thu, 13 Jun 2024, 10:39 AM

In our recent Infrastructure Day, we put together an array of speakers from both the public and private sectors and business associations, who shared with us the outlook for the construction and water sectors in Malaysia, as well as infrastructure development in Penang state. The speakers generally agreed that it is high time for Malaysia to double down the investment in public infrastructure, especially public transport and water projects, to enhance quality of life, liveability of Malaysia and attract investment. Our top infrastructure-related picks are: GAMUDA (OP; TP: RM6.70) and ENGTEX (OP; TP: RM1.41).

Session One: “Driving Economic Development for Penang” by YB Zairil Khir Johari, Exco (Infrastructure, Transport & Digital), Penang State Government

Penang has three major attractions, i.e., a manufacturing economic powerhouse, a popular tourist state and a highly liveable place. While it is the second smallest state in Malaysia, Penang contributes one third of nation’s exports, and 40% in services such as tourism and hospitality. In 2023, Penang had received foreign manufacturing investment of RM72b, the highest in the country while GDP growth of 13.1% in 2022 (vs. national rate of 8.7%) was among the highest state in Malaysia. For tourism and hospitality, Penang has daily direct flights to Dubai, Doha, Shanghai, Chennai starting this year. It is the top retirement destination under MM2H program.

For latest infrastructure in Penang, there are two Penang state-funded projects (c.RM200m) for Penang major roads and third link Package 2 for a bypass from Ayer Itam connecting to Lebuhraya Tun Dr Lim Chong Eu, and Jalan Bukit Kukus, the tallest road in Malaysia. Silicon Island, a 20-year public-private partnership (PPP) project funded by GAMUDA with state government getting 30% revenue from land use. As of April, 16 acres land has reclaimed and should increase to 400 acres by end-2025. Eventually a 2,300-acre reclaimed island with earmarking 700 acres for industrial park and 60 acres for affordable housing. It is on flight path, therefore no tall buildings with maximum eight storey heights. First factory is expected to be up by 2027.

For ongoing project, Gurney Bay is a seafront park on reclaimed land. The land is being reclaimed by E&O (Not Rated) with Phase 1 already completed in Feb 2024 while Phase 2 is scheduled to be completed by 4QCY25. The project had reclaimed a total of 131-acre land for the state government. Phase 1 covers 11.2ha, Phase 2 of 28.8ha while the remaining 30% of land is sold to fund state projects such as highways. A bridge is being built from Gurney Bay to E&O’s Andaman island project.

YB Zairil mentioned a price tag of RM13b for the Mutiara Line of Penang LRT comprising Package 1 (civil work for Silicon Island to Komtar), Package 2 (civil work for Komtar to Butterworth) and Package 3 (turnkey system and rolling stock). The project is expected to kick start this year, to be completed by 2030.

The pre-qualification for Penang International Airport expansion was completed in Mar 2024 and the actual work is expected to begin in 3QCY24. The RM1.5b project will be funded by AIRPORT (ACCEPT OFFER; TP: RM11.00). Upon completion in 2028, the airport will be able to handle 12m passengers per annum. At present, the airport with a capacity of 6.5m passengers per annum handles 8m passengers per annum.

The Penang Hill Cable Car, a private finance initiative (PFI) project which costs RM200m-RM300m, is expected to have its groundbreaking in Jun 2024 and to be completed by 2027. This PFI project was awarded to Hartasuma Sdn Bhd with Austriabase of ropeway engineering company – Doppelmayr Seibahnen GmbH providing the cable car system. Doppelmayr is also the supplier of Langkawi cable car and Penang Hill funicular system.

On water supply, PBA Bhd is profitable. It has raised RM2b Sukuk, of which RM1.2b will go towards funding upgrading works. Penang state’s water consumption per capita of 300 litre a day is the highest in the country and way above 100 litres a day in Singapore. At present, Sungai Muda supplies 80% of Penang’s raw water requirement. It may not be able to cope with the demand from Penang by 2030. As such, Penang is planning to procure raw water from Sungai Perak. Perak state government agreed in May 2024 to supply water to Penang, although it has yet to decide if the form of the water, i.e. raw or treated.

Session Two: “Outlook and Challenges of the Construction Industry” by Mr. Oliver Wee, President of Master Builders Association Malaysia (MBAM)

The construction sector is one of the largest contributors to world economy, with more than USD10t spent on construction related to goods and services every year. This is equivalent to 13% of the global GDP and it employs 7% of the world’s working population. In Malaysia, an average annual construction contracts awarded of RM125b for the last five years, benefitting more than 1.5m individuals over 120 subsectors.

In the past five years, an average annual public project award was RM35.7b. Up until Mar 2024, RM5.5b worth of public projects was awarded, vs. RM70b allocation under Budget 2024. MBAM expects RM150b contracts to be awarded in 2024, including the Mutiara Line of Penang LRT, Pan Borneo Sabah Phase 1B, large-scale flood mitigation projects, Sabah-Sarawak Link Road, LRT 3 Reinstatement, Kuching Urban Transportation System-Green Line and Water related projects.

In the private sector space, there will be warehouse, factory and plant, non-residential as well as data centre projects. Malaysia is an attractive destination for data centres as local contractors are able to meet the fast-track requirement to deliver projects within 12 months thanks to a strong eco-system of players in M&E works, precast installation, IBS, cooling system, instrumentation, etc.

Meanwhile, Singapore-Johor Special Economic Zone, KL-Singapore High-speed Rail and Maharani Energy Gateway should buoy the construction sector over the medium to long term.

The construction sector has benefitted from the accelerated adoption of digitalisation during the pandemic. On the flip side, other challenges linger including stricter rules and regulations, shortage of labour, rising building material costs, disruption of supplier chain, higher compliance costs (including ESG that stipulates better labour accommodation) as well as rising overall costs of doing business. There are also many unresolved disputes dating from the pandemic era, which incur hefty legal cost, eating into profit margins. Mr Wee believes that to keep the sustainability of the industry, the players have to get the right contracting parties, price the contract correctly and do not over promise so that cost will not be overrun. The players have to maintain a stable supply chain. Timing payments are the best way to avoid disputes. Contractors should also invest in new technology to stay relevant.

Session Three: "Outlook of the Water Industry in Malaysia"by Dr. Asari Daud, President of Malaysian Water Association

The first piped water system was introduced by the British in 1804 during the colonial era. By late-19th century, urban households had access to piped but untreated water. Sand filtration began in 1906, leading to comprehensive water treatment plants. However, infrastructure was neglected during World War II, leaving only 23% of the population with treated water. The Third Malaysia Plan (1976-1980) significantly improved this, raising access to 85% by 1990.

Water should be seen as a strategic imperative for the economy, society, and national security ass it is finite. The government has identified four key areas of focus: (i) adequate water resources (i.e., off river storage or ORS); (ii) financial sustainability, (iii) reduced non-revenue water (NRW); and (iv) climate resilience.

Through sector reforms, Malaysia’s water services are now regulated under the Water Services Industry Act (WSIA) 2006, which introduced a new model that separates water asset ownership from operation. Previously, the water services industry was under the purview of each state government, leading to poor service quality and financial difficulties due to heavy borrowing from the Federal Government for Capex and challenges in covering Opex. Under WSIA 2006, the Federal Government established Pengurusan Aset Air Bhd (PAAB) to own and develop water infrastructure. This allows state water operators to focus solely on providing water services and improving efficiency, while PAAB will handle water infrastructure development and funding. Instead of owning the water assets, state water operators lease these assets from PAAB for operation and maintenance. PAAB uses the lease income to repay the Federal Government loan over time. Additionally, PAAB can secure more favourable financing rates compared to private concessionaires and the financial benefits of this structure are ultimately shared with the consumers through lower tariff rates.

The treated water coverage in Malaysia is 95.5% on average with urban area of 97.2% and rural area of 93.9%. The state of Melaka and Labuan have 100% full coverage while Kelantan has the lowest coverage of 69.3% followed by Sabah (89.0%) and Sarawak (89.6%). Meanwhile, the NRW level of the country is at 35.3% and the vital objective is to reduce NRW so that the operators are able to cover the high operating costs. The government has scheme to reduce NRW to 20% by 2030, and 15% by 2049, such as kick start water pipe replacement program. This initiative is essential to meet the growing demand from the increasing population and the expansion of data centres, which require efficient cooling systems. Currently, a proposal of ~RM4b is being submitted to Ministry of Finance (MOF). According to MWA, at present, the water distribution network in Malaysia consists of MS pipes (28.5%), asbestos-cement (AC) pipes (27.1%) and DI pipes (8.0%).

Dr Asari shared that the AC pipes will eventually be phased out completely due to the short useful life and health concerns, while certain MS and DI pipes in the system have already exceeded their useful lives.Dr Asari stated that water revenue needs to be increased by 30% in order to offset costs. Energy is one of the major costs of producing water, at 17% on average while some states such as Pahang spend more than 50% on energy cost. Among the unpaid bills of more than RM2b, the outstanding debts owing to TENAGA is the biggest portion. Currently, the water tariff is insufficient to cover operational costs in all states except Selangor, Penang and Perak, even after a hike of RM0.25/m3 on 1 Feb 2024. However, the additional revenue will be utilised for various purposes, including funding CAPEX and improving efficiency through faster repair works rather than solely covering OPEX. We understand that the increase will not completely close the deficit gap between revenue and expenses in the water sector. However, Dr Asari mentioned that the government is allowing another tariff adjustment in less than two years. Also, the Tariff Setting Mechanism (TSM), introduced in August 2022, mandates that tariff rates be reviewed every three years.

Session Four: “Malaysian Construction Industry: The Road Ahead” by Mr. Prem Kumar, Executive Director, HSS Engineers Bhd

The local construction market is expected to grow at 4.4% in 2024 and is set to grow average of 5.8% per annum between 2025-2027. In 2023, the Malaysian construction market size was estimated at USD35.5b and is set to reach USD67.3b in 2033, growing at a CAGR of 8.6%. The implementation of major infrastructure projects and award of contracts will be accelerated in 2024 to pump prime the economy. These projects will be government-funded or implemented through the privatisation model.

Among the key focus areas are:

(i) Transportation:

(a) Road and highway: Pan Borneo Highway Sabah -Phase 1B; PJ Dispersal Link; Plus Highway widening; Sabah &Sarawak coast, and various other privatisation proposals such was urban highways

(b) Railway and transit: Penang LRT Mutiara Line; Trans Borneo Railway; Johor LRT; MRT3; and HSR

(ii) Water and Flood Mitigation

(a) Over RM12b allocation for flood mitigation projects, letter of acceptance (SST) to be issued soon.

(b) More than RM300b will be needed for long-term solutions to the country’s flood problems over the next 50 years.

(iii) Ports and other sectors

(a) Marine/ports: Westport Phase 2; Miri Port; and, Kuching Port

(b) Other sectors: data centre; industrial/logistics; renewable energy; hospitals; and, housing/real estatePrivatisation increases the private sector’s participation in economy. It transfers risks to the party that can manage them better.

Privatisation capitalises on the private sector’s technical capabilities and innovation as well as higher productivity and efficiency.

Malaysia has plenty of success stories on privatisation which brought about world-class infrastructure projects, i.e., North South Expressway, Pelabuhan Tanjung Pelepas and JKR HQ Building. Malaysia is “exporting” its privatisation expertise to India, Indonesia and the UAE.

Meanwhile, high industry fragmentation is one of the major challenges in the construction sector as projects owners, contractors, consultants all have different version of the truth, hence intense competition. Lack of planning in development phases, weak project monitory, poor selection of project team are also the challenges face by the players. Besides, cost overruns and delays, regulatory approvals lack of information are also the issues face by the industry. The lack of innovation which leads to 20% longer time to finish the project and up to 80% over budget, this haven’t moved forward much for the past 20 years.

In efforts to improve the progress of the construction industry, HSS embarks on digital innovation in three areas, i.e., (i) drone for construction – a progress monitoring, traffic monitoring and update to geographic information system (GIS); (ii) building information modelling (BIM) – it is a digital representation, which combines 3D models, of a building or infrastructure projects. However, adoption rate is low at about 30%; and, (iii) MYSITEBUDDY – an APP with quality management and Health, Safety and Environment (HSE) for construction site documentation.

Our top infrastructure-related picks are:

GAMUDA for: (i) being the front-runner for the tunnelling job for the MRT3, (ii) it has garnered a slice of action in the lucrative data centre building sector and positioned for more; and (iii) its ability to secure sizeable jobs in overseas markets.

ENGTEX for its dominance in both large-diameter mild steel (MS) pipes and ductile iron (DI) pipes, of which demand is poised to surge once large-scale water pipe replacement and new water projects get off the ground.

Source: Kenanga Research - 13 Jun 2024

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