• Still OVERWEIGHT; Top Picks: Gamuda, Sunway Construction (SunCon), and Kerjaya Prospek. Out of the 10 firms under our coverage that reported results, four were in line, two exceeded expectations, and four fell below estimates. The latter group were mostly earthworks and piling players that are still impacted by cost overruns. All in, we believe contractors should continue booking-in better progress billings. This is evident from the total value of works done at MYR34.1bn (+6.7% YoY), ie the highest in 15 quarters amidst an ample labour supply situation.

• The market is anticipating the rollout of certain infrastructure projects that have been making headlines. The ones we expect to make a debut in the coming months include the: i) Penang Light Rail Transit (LRT) (finalisation of details likely to be known during the first parliamentary meeting ending March), ii) MYR11.8bn nationwide flood mitigation projects under Budget 2024, and iii) reinstatement of the five LRT3 stations. For Mass Rapid Transit 3 (MRT3), we envisage the rollout to be after 4Q24, as MRT Corp is only set to finalise the land to be acquired in 3Q24 (Figure 8).

• While the market awaits such rollouts, we take comfort from the slew of private sector projects that we think may continue to grow, particularly in the industrial space. According to the National Property Information Centre, the value of transactions for industrial properties grew by 13.1% YoY in 2023. On further scrutiny, the new planned supply of industrial properties saw outstanding growth of nearly 200% to reach 1,372 units (2022: 468 units) – this should keep contractors busy going ahead (Figures 3 & 4). Foreign investments into Malaysia should also potentially bring in demand for factories and warehouses to be built.

• A key catalyst would be a faster-than-expected progress for the request for information for the Kuala Lumpur-Singapore High Speed Rail (HSR) project.

• Valuations. The Bursa Malaysia Construction Index (BMCI) is trading at 14.2x P/E, slightly above its 10-year mean of 12.7x. Nevertheless, the index traded near 16x P/E in 2017 during the construction upcycle, ie the period where most contractors saw upticks in job wins (Figure 6). With commendable catalysts in store for the sector, we believe the current valuations of the index still have some room to exhibit an uptrend. The presence of sizeable industrial jobs – eg data centres (which were absent back in 2017) – may possibly push the BMCI even higher than before.

• Gamuda, Kerjaya Prospek, and SunCon – given commendable earnings visibility over the next two years – are our Top Picks. Gamuda has a sizeable presence overseas while still retains domestic relevance. Kerjaya Prospek and SunCon do not only have steady pipelines from related-party transactions with their parent firms, but also have ongoing involvements in industrial jobs. Key downside risks to our sector call are longer-thanexpected delays in contract rollouts and larger-than-expected cost reductions for the MRT3 project.

4Q23 Results At a Glance

Overall, the construction sector delivered FY23 results that were within expectations. Out of the 10 companies under our coverage that reported results, four were in line, two exceeded expectations, and four fell below estimates. The companies that underperformed were Malaysian Resources Corp (MRCB), KKB Engineering (KKB), Econpile Holdings (Econpile), and Advancecon.

On the other hand, the quarterly performance of Gabungan AQRS, Pintaras Jaya, Kerjaya Prospek, and MGB met expectations. IJM Corp (IJM) and SunCon’s results exceeded projections.

Separately, Gamuda – which reported its 1QFY24 (Jul) earnings in Dec 2023 – was in line with expectations. Core profit in 1QFY24 stood at MYR195m (at +2.4% YoY if we compare with 1QFY23, which still had residual recognition from toll highways). We also expect stronger quarters ahead, owing to its property division and the Sydney Metro West project in Australia.

Value of construction work done continues to rise. The economic output of the construction sector grew 6.1% YoY in 2023 (2022: +5% YoY). Likewise, the total value of construction work done in 4Q23 grew by 6.7% YoY (+2% QoQ) to reach MYR34.1bn – the highest in 15 quarters. With that, the total value of construction works done in 2023 stood at MYR132bn, ie the highest in four years.

In sub-sector terms, the value of construction works done in 2023 for the civil engineering sub-sector saw the largest rise (+16% YoY). While major infrastructure projects signalled by the Government have yet to be rolled out, the rise in the value of construction works done for the civil engineering sub-sector could likely be underpinned by the ramping-up of works by contractors on existing projects – this is amidst better labour supply and operating conditions.

Meanwhile, non-residential buildings was the sub-sector that recorded a 3.1% YoY growth in terms of construction works done, ie the smallest among the sub-sectors. The reason for this could be due to many industrial buildings jobs – eg warehouses, data centres, and semiconductor facilities – still being in their early stages of construction. Such projects may see a pick-up in the coming quarters.

The value of construction works done for non-residential buildings in 2023 amounted to MYR28.8bn, ie 2.3% YoY higher than the MYR27.8bn booked in 2022. This indicates that demand to construct residential buildings remains strong in light of ongoing launches by the property developers.

Demand for industrial properties continues to stay strong. The number of new planned supply under the industrial property sub-sector surged to 1,372 units vs the previous five years, which only hovered below 900 units. On further scrutiny, the number of industrial properties that started construction in 2023 reached 803 units, ie the highest since 2018 at 901 units (Figures 3 & 4).

We hold the view that semiconductor facilities and data centres will underpin the growth in industrial properties. This is backed by robust trends in investors, with the country recording the highest-ever approved investments of MYR329.5bn in 2023 (up 23% from 2022’s numbers). More importantly, the awarding of contracts pertaining to industrial jobs should keep contractors occupied before the slew of large-ticket infrastructure projects are rolled out. Even if the MRT3 project gets awarded this year, we believe some time may be taken for the land acquisition process to be completed before any major works can commence.

Valuations. The BMCI is trading at 14.2x P/E, ie slightly above its 10-year mean of 12.7x. Nevertheless, the index was trading near a P/E of 16x in 2017 during the construction upcycle, ie the period in which most large-cap contractors saw upticks in job wins (Figure 6).

With the anticipation of new job wins potentially reverting back near 2017 levels amidst the upcoming infrastructure projects in the pipeline – eg MRT3, Penang LRT, Pan Borneo Highway Sabah Phase 1B, and the HSR – we think the current valuations of the index still have some room to exhibit uptrends. The presence of sizeable industrial jobs such as data centres (which were absent back in 2017) may possibly push the BMCI even higher than before.

All in, we remain OVERWEIGHT on the construction sector. We advocate investors to be selective on counters that have credentials in local public infrastructure projects while still having decent exposure – either in overseas markets or private industrial jobs – in addition to having lean balance sheets (net cash or manageable net gearing positions). Such attributes are crucial to weather any downside risks that may arise from unexpected labour shortages, a slow rollout of public infrastructure projects in Malaysia, and prolonged rise in building materials costs. Contractors that suit these criteria are Gamuda, SunCon, and Kerjaya Prospek.

We favour Gamuda due to its ongoing regional expansion – ie c.50% of profits from overseas markets – while still retaining relevance domestically by venturing into projects such as the Upper Padas Hydroelectric Dam in Sabah and remaining as a contender for the MRT3 tunnelling package. Gamuda’s 60%-owned subsidiary, SRS Consortium, will likely be the project delivery partner of the Bayan Lepas LRT as per the master agreement – provided that there are no changes post the Government’s takeover of said project.

Kerjaya Prospek and SunCon are both in the sweet spot to leverage on the growth of industrial buildings in the country. The former, under its partnership with Samsung C&T, is looking to secure more industrial building jobs, eg factories and warehouses. The group’s net cash pile of more than MYR100m should enable it to easily gear up for larger jobs in future if required.

On top of securing industrial building jobs in 2023 worth c.MYR500m in total, SunCon’s prospects continue to be backed by its more than MYR20bn tenderbook. This is in addition to the steady flow of internal jobs from its parent, which contributes 30-40% of the group’s construction orderbook.

Downside risks to our OVERWEIGHT stance on the construction sector include:

i. Slower-than-expected rollout of mega projects;

ii. The rollout of projects with larger-than-expected cuts to their overall costs;

iii. An unexpected shortage of labour supply for the construction sector.

Source: RHB Securities Research - 13 Mar 2024