The construction sector has been the focal point of the market over the past year, driven by strong contract flows, as major tech giants and data centre operators began establishing Malaysia as one of their data centre hubs on the private front. Contract flows remain robust in the near term, with 7,200MW worth of data centre opportunities by 2035. Together with the public project the MRT3 which is undergoing public inspection until early December, this could by 2025 propel total contract awards past the 2016 peak, if it materialises. Other projects in the pipeline include the Pan Borneo Highway, Sabah Sarawak Link Road, Penang Airport Expansion, and Subang Airport Redevelopment Plan. We maintain our OVERWEIGHT rating for the sector, supported by OUTPERFORM for GAMUDA (TP: RM9.20) as the sector TOP PICK, and beyond that, we still see favourable risk-reward ratio for the mid-to-smaller cap builders.

Strong contract flows. According to the Construction Industry Development Board (CIDB), a total of RM127.6b in main contractor construction contracts was awarded YTD as of the end of August 2024, representing 85% of the total contract awards of RM150.9b in 2023. Of the RM127.6b, government projects accounted for 26%, while private projects made up 74%. Although contract flows remain strong, we believe total awards in 2024 are unlikely to surpass the previous upcycle record of RM241b in 2016 (which included the lumpy East Coast Rail Link), given the remaining three months of the year. With several public projects in the pipeline, coupled with robust private sector projects, especially in the data centre sector, 2025 is expected to be another busy year.

Several public projects in the pipeline. The MRT3 is undergoing public inspection until early December, with booths available at 35 designated locations along the alignment areas as well as government offices. This gives the public an opportunity to review and provide feedback on the proposed plans, as a required step alongside railway scheme approval. MRT Corp expects construction of the MRT3 to begin in 2026, with the entire MRT Line anticipated to be fully operational by 2032. If this timeline materialises, we believe 2025 could surpass the 2016 peak for contract awards. Other major projects in the pipeline include the Penang LRT Mutiara Line, currently pending negotiation between SRS Consortium and MRT Corp, and the Penang Airport Expansion, which is expected to conclude soon. Additionally, the Pan Borneo Highway, Sabah Sarawak Link Road, and Subang Airport Redevelopment Plan are on the horizon. We view the high-profile KL-Singapore High-Speed Rail as a medium-term prospect, while the upcoming Johor-Singapore Special Economic Zone (SEZ) also presents opportunities for the construction sector.

Data centre to lead private project growth. Major tech giants like Amazon, Google, and Microsoft, along with other data centre operators, have announced significant investments in Malaysia's data centre sector. According to TENAGA's (OP; TP: RM17.00), there are 7,200MW of data centre opportunities, with 4,000MW already secured. This could generate approximately RM21b in construction contracts annually (assuming 700MW a year). We believe large-cap builders such as GAMUDA, IJM (MP; TP: RM3.16) and SUNCON (MP; TP: RM4.71) have a competitive advantage due to their Industrial Building System (IBS) solutions, allowing them to accelerate project timelines. Data centre projects are typically fast-tracked, requiring shorter construction times, which naturally command higher profit margins

Current valuation comparable to the 2016 up-cycle. The construction index has performed exceptionally well this year, partly driven by the data centre boom, with the KLCON index soaring 50% YTD compared to the FBMKLCI's 15% gain. Large-cap contractors have also seen their share prices rallied, between 62% and 133% over the same period. This puts the sector's valuation on par with, or even surpassing, the 2016 upcycle. However, we believe higher valuation multiples are justified this time around, given the expected higher annual contract awards of RM180b over 2024-2026, 11% higher as compared to RM161b annual contract award during the previous up-cycle in 2016-2018. As a result, we now value the large-cap contractors at a PER of 22x, a 10% increase from 20x, aligning with the current KLCON index trading multiple of 22x. However, we maintain our earnings multiples for mid- to smaller-cap contractors between 12x and 16x, as they are less likely to benefit from the data centre boom.

Maintain OVERWEIGHT for the sector, anchored by Gamuda for larger caps. At 22x PER for construction business, our target price for GAMUDA is upgraded to RM9.20 (from RM7.54), IJM to RM3.16 (from RM3.00), and SUNCON to RM4.71 (from RM4.28); among these, only GAMUDA’s recommendation is upgraded from MARKET PERFORM to OUTPERFORM. Meanwhile, we expect better risk-reward profile for the mid-to-small cap builders. The target prices for KERJAYA (OP; TP: RM2.24) (16x), KIMLUN (OP; TP: RM1.69) (12x) and WCT (OP; TP: RM1.43) remain unchanged. We maintain our sector rating of OVERWEIGHT with GAMUDA our Top Pick for the sector for: (i) being in the driver’s seat for the Mutiara Line of the Penang LRT and front-runner for the tunnelling job for the MRT3, (ii) its ability to secure new jobs in overseas markets, (iii) its strong war chest after the disposal of its toll highways, (iv) its strong earnings visibility underpinned by a record outstanding order book of RM26.5b (excluding Upper Padas Hydro and Penang LRT), and (v) its inroads into the renewable energy space.

Strong contract flows. According to data compiled by CIDB, a total of RM127.6b in main contractor construction contracts was awarded in 8MCY24, equivalent to 85% of the total contract awards of RM150.9b in 2023. Of the RM127.6b, government projects accounted for 26%, while private projects made up the remaining 74%. Although contract flows remain strong, we believe the total awards in 2024 are unlikely to surpass the last upcycle record of RM241b in 2016, as a matter of timing. Looking ahead, with impending public projects, along with robust private sector projects, especially in the data centre sector, 2025 is expected to shape up into another busy year. We have projected an average of RM180b annual awards over 2024-2026 which is 11% higher than the average of RM161b for the 2016-2018 upcycle.

MRT3 to start public inspection. MRT Corp has initiated a public inspection for the MRT3 (Circle Line) from 2 September to 2 December. Public inspection booths are available at 35 designated locations, including eight info kiosks and 27 info trucks along the alignment areas, as well as government offices like the Ministry of Transport, the Land Public Transport Agency (APAD), DBKL, and MPAJ. The public inspection provides an important opportunity for the public to review and provide feedback on the proposed alignment, site and context plans, and other key project details – a necessary pro-active step that could help expedite progress in the construction phase. MRT Corp expects the construction of the MRT3 to begin in 2026, with the entire Circle Line to be fully operational by 2032. If the timeline is realised, we believe 2025 could surpass the 2016 peak for contract awards.

Several key infrastructure projects are in the pipeline, including the Penang LRT Mutiara Line, which has secured Federal government approval and is pending negotiations between GAMUDA’s 60%-owned SRS Consortium and MRT Corp. The Penang Airport Expansion is also expected to conclude soon. The Pan Borneo Highway for both Sarawak and Sabah, as well as the Sabah Sarawak Link Road, are pending roll-out. Meanwhile, progress on finalising the Subang Airport Redevelopment Plan remains slow and the high-profile KL-Singapore High-Speed Rail is likely to be a medium-term prospect for the construction sector. Lastly, there are opportunities for the sector from the impending Johor-Singapore Special Economic Zone (SEZ) as well.

Tech giants’ news flow still buoyant. Malaysia has become one of the leading global locations for data centre development due to its strategic location and supportive government policies. Over the past year, major tech giants such as Amazon, Google, and Microsoft have announced significant data centre investments in the country. In March 2023, Amazon Web Services (AWS) revealed plans to invest at least USD6b by 2037 in a new AWS Region in Malaysia. Since November last year, Microsoft has acquired land in separate deals with CRESNDO (Not Rated) for a total of RM447.6m and another with ECOWLD (UP; TP: RM1.41) for RM402.3m. In April this year, Microsoft announced USD2.2b investment in advanced cloud and AI infrastructure over the next four years to support Malaysia’s digital transformation. Similarly, in May, Google committed USD2b to build its first data centre and “cloud region” in Malaysia. GAMUDA has secured RM1.74b contract from Google to build a data centre at SDPROP’s (UP; TP: RM1.36) Elmina Business Park.

Data centre job to lead private project growth. Existing players like NTT Global DC of Japan and Bridge Data Centres of Singapore are also expanding their presence in Malaysia by acquiring land for new data centre capacity. Additionally, several developers such as STT GDC, Epoch Digital, and Digital Hyperspace have purchased land to build data centres, primarily in Johor. The robust demand for data centres is aptly reflected by TENAGA, having signed Electricity Supply Agreements (ESA) for a total demand of 4,000MW as of June this year, spanning 26 data centre projects to ensure reliable and fast electricity supply. Furthermore, there are 21 projects in the pipeline with an additional demand of 3,200MW currently at the application stage. Assuming these projects are completed over the next 10 years, an average of 700MW of new data centre capacity will be built annually. With a rough estimate of RM30m in construction costs to build 1MW of data centre capacity, a 700MW data centre would generate approximately RM21b in construction contracts annually. This indicates substantial construction opportunities in this market segment.

Contractors are eager to jump on the data centre bandwagon. So far, SUNCON has secured the highest contract value, totalling RM3.4b in data centre projects. GAMUDA has also announced securing RM1.74b worth of Google data centre projects at Elmina Business Park from Google and SDPROP in May this year, in addition to three blocks of AIMS data centres in Cyberjaya. IJM is the third-largest construction company to secure data centre projects, with two contracts totalling RM585.7m, both located in Johor. Among the smaller contractors under our stock coverage, KERJAYA, WCT, and KIMLUM have also expressed interest in participating in data centre tenders. In our view, having Industrial Building System (IBS) solutions provides a competitive advantage for GAMUDA, IJM, and SUNCON, allowing them to accelerate project timelines. That said, profit margins for these contractors are expected to improve, as data centre projects tend to command higher margins compared to traditional projects. This is largely due to the fast-track nature of these projects, which require shorter construction times and naturally justify higher profit margins.

Current valuation comparable to the 2016 upcycle. The construction index has performed exceptionally well this year, partly driven by the data centre boom, with the KLCON index soaring 50% YTD, compared to the FBMKLCI index’s gain of 15%. Within our coverage universe, SUNCON led the gainers, with its share price more than doubling, up 133%. Larger-cap stocks like GAMUDA and IJM have also seen significant gains, with share prices rising over 60%. WCT (OP; TP: RM1.43) is the top performer among the smaller-cap stocks, with its share price doubling YTD. In terms of valuation, the current forward PER for major players like GAMUDA, IJM and SUNCON stand at 19x, 21x, and 32x, respectively. These are higher than their peak valuations during the previous upcycle in 2016, which were 20x, 19x, and 17x, respectively. This suggests that the current valuation for the sector is either on par with or surpassing the 2016 upcycle valuation.

However, we believe higher valuation multiples are warranted this time, given the expected higher annual awards of RM180b for 2024-2026, +11% against the previous upcycle of RM161b in 2016-2018. As such, we apply a 10% premium to derive a new target PER of 22x for the sector, from the 20x seen earlier. Therefore, we raise the targeted PER for the large-cap contractors - GAMUDA, IJM and SUNCON - from 20x to 22x. This leads us to upgrade our target prices for GAMUDA to RM9.20 (from RM7.54), IJM to RM3.16 (from RM3.00), and SUNCON to RM4.71 (from RM4.28). Our new target price of GAMUDA also supported by: (i) a roll-over of valuation base year to FY26 from FY25 (FYE: July); and (ii) a revised 40% discount (from 50%) to its RNAV for property segment given its aggressive property launches of late; our revised RNAV is supported by an implied property PER of 9x (same as IJM’s implied property PER) against mid-teen earnings multiples for big-cap property companies under our universal coverage. On the other hand, we maintain our earnings multiples for KERJAYA (OP; TP: RM2.24) (16x), KIMLUN (OP; TP: RM1.69) (12x) and WCT (12x), as we believe the mid- to smaller-cap contractors are less likely to benefit from the data centre boom. Accordingly, our target prices for KERJAYA, KIMLUN and WCT remain at RM2.24, RM1.69, and RM1.43, respectively.

Maintain sector rating of OVERWEIGHT. We upgrade GAMUDA to OUTPERFORM from MARKET PERFORM as it will lead the sector in this upcycle boom while IJM and SUNCON are held at MARKET PERFORM. The mid- to smaller-cap contractors KERJAYA, KIMLUN and WCT retain their OUTPERFORM ratings. GAMUDA is our Top Pick for the sector for: (i) being in the driver’s seat for the Mutiara Line of the Penang LRT and front-runner for the tunnelling job for the MRT3, (ii) its ability to secure new jobs in overseas markets, (iii) its strong war chest after the disposal of its toll highways, (iv) its strong earnings visibility underpinned by a record outstanding order book of RM26.5b (excluding Upper Padas Hydro and Penang LRT), and (v) its inroads into the renewable energy space.

Source: Kenanga Research - 25 Sept 2024