We  remain  OVERWEIGHT  on  the  construction  sector.  We  like  this sector  due  to  its  strong  earnings  visibility,  backed  largely  by  the MYR73bn  Klang  Valley  MRT  project  that  will  keep  players  busy  until 2021.  We  also  see  opportunities  for  players  in  the  public  housing segment as well as in  East Malaysia.  Our  Top  Picks for the sector are Gamuda, Protasco and Hock Seng Lee.

• Maintain OVERWEIGHT.  We  believe investors should stay invested in the construction sector  on  strong earnings visibility  backed by: i) record or  close-to-record  outstanding  orderbook  for  most  players  at  present, and ii) more new jobs in the pipeline including the Klang Valley MRT Line 2  project,  Kwasa  Damansara,  the  Refinery  &  Petrochemical  and Integrated Development (RAPID) project in Pengerang, several new toll roads,  as  well  as  Track  3A  and  Track  3B  power  plant  projects.  Main triggers: i) the Klang Valley MRT  project, ii) public housing, and iii) East Malaysia/Sarawak Corridor of Renewable Energy (SCORE).
• Our  top  pick  is  Gamuda  for  MRT  exposure.  The  Klang  Valley  MRT project  is  the  main  pillar  of  support  to  the  current  upcycle  given:  i)  its massive  contract  value  of  MYR73bn,  ii)  which  reverberates  along  the entire value chain of the sector, creating orders for management, general and  specialist  contractors,  as  well  as  suppliers  of  various  building materials, and iii) its long construction period  of  approximately  10  years from 2012 to 2021. We believe Gamuda  (GAM MK,  BUY, FV: MYR5.45) is the biggest beneficiary of the project.
• Protasco  for  public  housing.  The  provision  of  public  housing  has become a lucrative business  for  the private sector,  thanks to  a  MYR1bn allocation  for  the  Housing  Facilitation  Fund  under  the  2014   Budget. Protasco  (PRTA  MK,  BUY,  FV:  MYR2.18)  has  thus  far  secured  the highest number of public housing contracts.
• Hock  Seng  Lee  for  East  Malaysia/SCORE.  East  Malaysia  will  see infrastructure works coming from three main initiatives: i) SCORE (roads, water  supply  and  port),  ii)  urbanisation  (flood  mitigation,  waste management  and  traffic  diversion),  and  iii)  rural  development  (roads, water supply and housing). We believe Hock Seng Lee (HSL  MK,  BUY, FV: MYR2.06) is the best construction proxy to East Malaysia/SCORE.

Second Job Wave Hits The Shore
Strong earnings visibility
We maintain our  OVERWEIGHT  stance on the construction sector.  We believe  the main  trigger  lies  with  the  sector’s  strong  earnings  visibility  in  the  immediate  to medium term, backed by:  i) record or close-to-record outstanding orderbook for most players, and ii) more new jobs in the pipeline.

The strong outstanding orderbook  for most players has  been fuelled by a new wave of  spending  and  investments  over  the  last  2-3  years  by  the  Government, government-linked companies (GLCs) and the private sector ,  including foreign direct investors.  This  is  in  response  to  the  Economic  Transformation  Programme   (ETP) introduced in Oct 2010, anchored by the MYR23bn Line 1 of the Klang Valley MRT project.

We expect more new jobs in the pipeline for construction players over the immediate to  medium term on the back of a second wave of spending and investments by the public  and  private  sectors.  In  fact,  the  second  wave  is  already  hitting  the  shore. Among the signs are an energised public housing segment with the award of several large-scale  public  housing  contracts  since  end-2013,  and  a  surprisingly  low-key ground-breaking (actual work, not ceremony)  of Warisan Merdeka with the MYR74m foundation works  awarded  to  Pintaras Jaya (PINT MK, BUY, FV: MYR3.50  in March comprising diaphragm wall, piling and excavation.  The job, which is to be completed by  the  piling  specialist  in  12  months,  is  a  precursor  to  the  award  of  more  work packages, ie  the redevelopment of the 19-acre Stadium Merdeka site in the heart of Kuala  Lumpur  into a  new  MYR5bn  business  district,  with  the key  feature  being  an iconic 118-storey skyscraper or the equivalent of over 350 meters (see Figure 1). We also expect news flow on several other fronts to pick up from 2Q2014, including the Klang Valley MRT  Line 2  project, Kwasa Damansara (redevelopment of  the  Rubber Research Institute land in Sungai  Buloh), the  RAPID  project in Pengerang, several new toll roads, as well as Track 3A and Track 3B power plant projects.

Our top three themes in construction stocks are: i) the Klang Valley MRT project, ii) public housing, and iii) East Malaysia/ SCORE.

Klang Valley MRT

The Klang Valley MRT project is the main pillar of support to the current upcycle in the  local  construction  sector,  given:  i)  its  massive  contract  value  of  MYR73bn comprising  Line  1  worth  MYR23bn  (under  construction)  and  Lines  2  &  3  worth MYR25bn each (under planning), ii) that it reverberates along the entire value chain of  the  construction  sector,  creating  orders  for  management,  general  and  specialist contractors, as well as suppliers of building materials such as precast components, cement and steel bars, and iii) its long construction period,  which  we project at  10 years  from  2012  to  2021.  That  said,  from  a  risk  angle,  we  acknowledge  that  it  is extremely crucial that the Government does not backpedal on its commitment to  the project implementation, and equally important, the timeliness of the implementation.We  believe  the  best  proxy  to  the  Klang  Valley  MRT  project  is  Gamuda,  as  it  has secured a 50:50 MMC-Gamuda joint venture (JV) for the best part of the MRT Line 1 project (and most likely Lines 2 and 3 as well), by being: i) the project delivery partner (PDP) for the elevated portion, which  the JV earns a PDP fee amounting to 6% over the elevated portion’s contract value of about MYR14bn, and ii) the main contr actor for the tunneling portion, which we believe the JV earns   a margin of 12% over the tunneling portion’s contract value of MYR8.3bn.

Public housing
Although deemed unattractive in the past, the provision of public housing has now become a lucrative business  for the private sector,  thanks to  the  MYR1bn allocated to  the  Housing  Facilitation  Fund  under  the  2014  Budget.  Among  the  key  public housing schemes that  utilise  the MYR1bn Housing Facilitation Fund (so that buyers can  enjoy  a  10-20%  discount  to  market  prices)  are  1Malaysia  Public  Housing Programme (PR1MA) and 1Malaysia Civil Servants’ Housing Programme (PPA1M). Unlike the existing ordinary public housing schemes targeting the low-income group –which are  implemented by various government agencies  –  PR1MA promotes home ownership  in  “key  urban  centres”  at  affordable  prices  of  between  MYR100k  and MYR400k  for  the  middle-income  group  (with  monthly  income  of  MYR2,500-7,500). Likewise, PPA1M promotes affordable housing for government servants in Putrajaya, the  federal  administrative  centre.  We  believe  the  margins  from  t hese  projects  are attractive given: i) that the contracts are awarded largely on a direct-negotiated basis, ii) the “straightforward” nature of the jobs (ie the contractor builds the units and hands over to the Government to sell), and iii) the inherently relatively low execution risk for building jobs.

We believe the best proxy to public housing is Protasco, as it has already bagged two public housing projects worth a total of MYR667m comprising: i) 1,680 apartments in Putrajaya under  PPA1M  (MYR579m),  and  ii) 1,144  single-storey  terrace  houses  in Negeri Sembilan and Perak under PR1MA (MYR88m).

East Malaysia/SCORE
The prospects for the construction sector in East Malaysia are strong, underpinned by infrastructure works from three main initiatives, namely: i) SCORE (roads, water supply  and  port),  ii)  urbanisation  (flood  mitigation,  waste  management  and  traffic diversion), and iii) rural development (roads, water supply and housing).  Players in Sarawak  also  enjoy  sustained  high margins  due  to  limited  competition  from only  a small pool of Sarawak state-registered (UPK) contractors for mostly public jobs in the state.  We  believe  Hock  Seng  Lee  is  the  best  construction  proxy  to  East Malaysia/SCORE.

Source: RHB