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Norah Freeman
5 years ago
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1 Robust outlook despite non-construction drag The 2Q17 results for the Construction Sector were generally below expectations. Strong earnings growth for the companies construction divisions was held back by weaker earnings for their non-construction businesses. However, the sector charted strong aggregate core EPS growth of 9% qoq and 23% yoy in 2Q17. We remain Overweight on the sector on the positive outlook on contract awards, which should accelerate in 2H17 with major packages for LRT Line 3 rolling out. Our top BUYs are Gamuda, WCT and HSS. Strong sector core earnings growth in 2Q17 The construction sector s aggregate core EPS grew 23% yoy in 2Q17, the fourth consecutive quarter of positive growth and accelerating from 6% yoy in 1Q17. This was mainly driven by higher construction earnings as progress billings accelerated on new construction contracts secured last year. The property divisions for the companies under our coverage, such as Gamuda, IJM Corp, WCT, MRCB and AQRS, saw weaker earnings. Suncon saw weaker earnings from its precast concrete division due to a lower sales volume as construction progress for a main contractor slowed. LRT3 contract awards likely to accelerate We expect contract awards to accelerate in 2H17 as major packages of Light Rail Transit Line 3 (LRT3) project are rolled out. To date, RM3.4bn worth of contracts have been awarded for the LRT3 project and indications are the total contract value could exceed the initial estimate of RM10bn. WCT and TRC Synergy won LRT3 packages of RM1.03bn and RM0.76bn respectively. We believe the remaining packages will be awarded by early October. Other contractors vying for the remaining packages should include Gamuda, IJM Corp, Suncon, AQRS, Mudajaya, Fajarbaru, Gadang and unlisted Syarikat Muhibbah (AQRS Bumiputera partner). Higher development expenditure for Budget 2018 We believe the government will increase the allocation for development expenditure in the upcoming Budget 2018 to be announced on 27 October We forecast the development expenditure budget to increase to RM50bn in 2018 compared to RM46bn in 2017 to meet the RM260bn target spending in under the 11 th Malaysia Plan (11MP). This augurs well for the construction sector with more public sector projects. Remain Overweight We are Overweight the construction sector as news flow on contract awards should sustain sector outperformance in 2H17. The award of subcontract works for the RM55bn East Coast Rail Link (ECRL) project is expected to start in 4Q17. We see more value in small/mid-cap names like WCT and HSS. In large caps, we prefer Gamuda over IJM. Risks: project delays and rising construction costs. Sector Update Construction Overweight (maintain) Absolute Performance (%) 1M 3M 12M IJM (0.29) (0.40) 1.65 Gamuda (0.37) MRCB - (14.48) (6.59) WCT (4.76) (15.89) Suncon AQRS WZ Satu (0.93) (9.32) 4.82 Pintaras (4.13) HSS Relative Performance (%) Stock Bbg Rating Sh Pr TP Mkt cap Core PER (x) Core EPS gr (%) P/BV (x) ROE (%) DY (%) (RM) (RM) (RMbn) CY17E CY18E CY17E CY18E CY17E CY17E CY17E IJM Corp IJM MK HOLD Gamuda GAM MK BUY MRCB MRC MK HOLD (43.3) WCT Hldgs WCTHG MK BUY SunCon SCGB MK HOLD Gbg AQRS AQRS MK BUY WZ Satu WENG MK BUY Pintaras PINT MK BUY HSS HSS MK BUY Wgt avg Source: Affin Hwang forecasts, Bloomberg. Note: Pricing as of close on 7 September 2017 AQRS Suncon Pintaras Gamuda WCT IJM WZ Satu MRCB (20) Source: Affin, Bloomberg. *HSS was listed only on Aug 26, 2016 Loong Chee Wei, CFA (603) cheewei.loong@affinhwang.com Page 1 of 11

Aggregate sector net profit was flat in 2Q17 mainly due to lower exceptional gains and unrealised forex losses due to the strengthening of the Ringgit that reduced income from overseas operations for

2 Strong sector core earnings growth in 2Q17 Aggregate construction sector core net profit grew 23% yoy and 6% qoq in 2Q17. All the construction companies under our coverage reported better yoy core earnings except HSS, Pintaras and Suncon. Aggregate sector net profit was flat in 2Q17 mainly due to lower exceptional gains and unrealised forex losses due to the strengthening of the Ringgit that reduced income from overseas operations for IJM, WCT and Suncon. We believe sector core EPS growth is on track to rebound from a 7% yoy contraction in 2016 to expansions of 21% yoy in 2017E and 18% yoy in 2018E, driven by higher progress billings on burgeoning construction order books. Fig 1: Aggregate construction sector core net profit and yoy change Source: Affin Hwang, Companies Fig 2: Aggregate construction sector net profit and yoy change Source: Affin Hwang, Companies Page 2 of 11

3 Better operating profit margins Construction operating profit margins for all the construction companies under coverage were better yoy in 2Q17 except for Pintaras and WZ Satu. The ramp-up in contribution from new projects that derive better margins led to the improvement in the blended margins for most of the contractors. Fig 3: Construction operating profit margin Year to 31 Dec 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 Gabungan AQRS (14.6) 6.8 (2.1) (0.1) Gamuda IJM MRCB (24.6) Pintaras Jaya NA NA (14.4) Suncon WCT (4.2) WZ Satu Source: Affin Hwang, Companies LRT3 contract awards likely to accelerate We expect contract awards for the remaining packages of the LRT3 to be awarded by early October The initial target completion date for the project was But given the delays in the award of the packages, the completion could be extended. Gamuda has a competitive advantage in bidding for the underground package of the LRT3, while other contractors vying for the remaining above-ground station and elevated viaduct packages are likely to include IJM Corp, Suncon, AQRS, Mudajaya, Fajarbaru, Gadang and unlisted Syarikat Muhibbah (AQRS Bumiputera partner). For exposure to potential LRT3 contract wins, we prefer AQRS and Suncon. At least RM6.6bn of remaining LRT3 packages to be awarded We estimate the total contract awards to date for the LRT3 project amounts to RM3.4bn. At least RM6.6bn worth of works are expected to be awarded for the remaining packages based on the government s initial cost estimate of RM10bn mentioned in Budget Fig 4: LRT3 contract awards Date awarded Company Value Package Works (RMbn) Apr-17 Mudajaya Group 58 PC2 Manufacture, supply and delivery of precast pier caps and other related works. Apr-17 TRC Synergy 761 TD2 Construction and completion of the Johan Setia depot (Phase 2). Apr-17 WCT Holdings 186 TD1 Build Johan Setia depot and associated works. Aug-17 Consortium owned by CRRC Zhuzhou Locomotive Co Ltd, Siemens Ltd China and Tegap Dinamik Sdn Bhd 1,600 NA Design, manufacture, supply, delivery, installation, testing and commissioning of 42 six-car LRVs for LRT3. Aug-17 WCT Holdings 840 GS03 Construction and completion of the guideways, stations, park and ride, ancillary buildings and other associated works. Total 3,445 Source: The Star, Company Page 3 of 11

4 Both infrastructure and property contract awards declined in 2Q17 Construction contract awards declined 69% yoy and 51% qoq to RM13.2bn in 2Q17 due to the weak new property launches and lower infrastructure project awards (-88% yoy and -68% qoq to RM2.4bn). Consequently, contract awards plunged 54% yoy to RM40.4bn in 1H17 from a high base in 1H16. There were no major infrastructure project awards in 1H17, while major packages for the Klang Valley MRT Line 2 (MRT2) had been awarded in 1H16. Property-related contract awards declined 27% yoy to RM27.9bn in 1H17 due to the weak property market condition and most property developers slowing down launches of new properties. Fig 5: Quarterly contract awards by government and private sector Source: Construction Industry Development Board As major projects such as the RM10bn LRT Line 3 and RM13bn Pan Borneo Highway (PBH) Sabah were still at the tender stage in 1H17, we expect contract awards to accelerate in 2H17 when winners are announced for major packages for these projects. Property-related contract awards should also pick up in 2H17 as major property developers are planning for more launches of new projects. LRT3 and ECRL should take off in 2H17 We estimate at least RM145bn worth of infrastructure contracts are pending award from 2H17 onwards, including new projects to be implemented. We gather that the remaining major work packages for the RM10bn LRT3 will be awarded in 2H17. The RM55bn ECRL is expected to take off in 4Q17 with main contractor China Communications Construction Co. Ltd (CCCC) set to award subcontracts worth at least 30% of the total project value to local contractors. Fig 6: Remaining contracts likely to be awarded from 2H17 onwards Project Cost (RMbn) Potential listed co bidders KL-Singapore High Speed Rail (HSR) 60 Gamuda, HSS, IJM, YTL, George Kent East Coast Rail Link (ECRL) 55 AQRS, Fajarbaru, Gamuda, HSS, IJM, WZ Satu, Advancecon Pan-Borneo Highway Sabah (PBH) 13 WCT, Suria Capital-GAQRS, Gamuda LRT Line 3 (Bandar Utama-Shah Alam-Klang) 7 Suncon, IJM, Gamuda, Gadang, Mudajaya, Fajarbaru Gemas-Johor Bahru Double-Tracking 5 YTL, Fajarbaru-WZ Satu Central Spine Road 4 UEM-WZ Satu West Coast Expressway 1 Mitrajaya, WCT, WZ Satu, Advancecon Total 145 Source: Affin Hwang estimates Page 4 of 11

New contract procurement likely to pick up in 2H17 The construction companies under our coverage had good results in terms of new contract procurements in 2016.

5 New contract procurement likely to pick up in 2H17 The construction companies under our coverage had good results in terms of new contract procurements in But this eased in the first 8 months of 2017 (8M17) as most of the packages for the MRT Line 2 had been awarded in IJM was the most successful in securing new contracts in 1H17, ie, RM1.3bn for the lifestyle retail mall in Bukit Bintang City Centre and Dewas Bypass Tollway in India. This was followed by WCT and Suncon at RM1bn and RM0.9bn respectively. We believe contract awards will accelerate in 2H17 with the award of the remaining packages for the LRT3 project and initial subcontract packages for the ECRL. Fig 7: Annual new contract awards for selected contractors Company M17 (RMbn) (RMbn) (RMbn) (RMbn) (RMbn) (RMbn) Gamuda * IJM Corp Suncon WCT * Includes MRT2 project delivery partner project. Source: Companies, Affin Hwang Record-high order books Most of the contractors in our universe have built up record-high order books due to strong new contract procurements in IJM expanded its order book to about RM9.2bn at end-1h17 from RM8bn at end-2016 with new contract wins, while others managed to replenish their order books back to about the same level. Gamuda still has the largest order book among the construction companies in our universe at RM17.3bn due to the MRT Line 2 project secured in MRCB has the highest order book/revenue ratio at 8.5x, indicating the highest earnings visibility supported by a large order book. WCT s order book/revenue ratio improved to 3.7x in September from 2.3x in June after it recently secured the RM0.84bn LRT3 package GS03 contract. Fig 8: Construction order book at September 2017 Fig 9: Order book/revenue at September 2017 Source: Companies Source: Companies We expect higher development exp. in Budget 2018 Forecast development expenditure of RM50bn for Budget 2018 We believe the government will increase the allocation for development expenditure in the upcoming Budget 2018 to be announced on 27 October We forecast the development expenditure budget to increase to RM50bn in 2018 compared to RM46bn in 2017 to meet the RM260bn target spending in under the 11MP. This augurs well for the construction sector as we believe more public sector projects will be implemented next year. Page 5 of 11

Look out for Central Spine Road allocation Some measures that could be implemented include further incentives to utilise Industrial Building Systems (IBS) in building construction.

6 Look out for Central Spine Road allocation Some measures that could be implemented include further incentives to utilise Industrial Building Systems (IBS) in building construction. There is a possibility for additional development expenditure allocation for the further phases of the Central Spine Road (CSR) project in Budget The CSR project will improve road connectivity to the interior areas of Peninsular Malaysia and Kelantan. From a political and socio-economic perspective, this is important for the ruling coalition given the upcoming general elections that may be called by March/April We understand that UEM Group and WZ Satu are negotiating for a CSR package worth about RM4bn. UEM Edgenta will likely be appointed the project manager while WZ Satu should be the main contractor if the project is secured. Fig 10: Malaysian government development expenditure and 11MP allocations Source: Ministry of Finance, Affin Hwang estimates Remain Overweight Top BUYs are Gamuda, WCT and HSS We remain Overweight on the Malaysian Construction Sector given the positive outlook on contract awards in 2H17. We expect the sector s EPS growth of 15% yoy in 2018E to outpace the market average of 6.8% yoy, all on our forecasts. The weighted-average construction sector fully-diluted 2018E PER of 17x is slightly above the market average of 16.7x. We believe the positive earnings delivery in E and sustained news flow on the award of major infrastructure projects will support the sector outperformance. Our top sector picks are Gamuda (for large-cap exposure), WCT (for mid-cap stocks), and HSS (for small-cap exposure). Page 6 of 11

Fig 11: Valuations and EPS growth for the Malaysian sectors and market Source: Bloomberg, Affin Hwang forecasts, based on prices as of 7 September 2017 Fig 12: Top picks in Malaysian construction

7 Fig 11: Valuations and EPS growth for the Malaysian sectors and market Source: Bloomberg, Affin Hwang forecasts, based on prices as of 7 September 2017 Fig 12: Top picks in Malaysian construction sector Top picks Rating Analysts Comments GAMUDA (GAM MK) BUY Gamuda is our top BUY among the large-cap Malaysian construction stocks, with an RNAV-based 12-month target price Target Price : RM5.94 of RM5.94. Gamuda and its partners have been appointed as Share Price as at 8 Sep 2017 : RM5.33 the project delivery partner for the RM32bn Klang Valley Mass Rapid Transit Line 2 (MRT2) and RM27bn Penang Transport (RM) Master Plan (PTMP). The MMC Gamuda Joint Venture was also 6.00 awarded the RM15.47bn underground works contract for MRT2, 5.50 while Naim-Gamuda JV clinched the RM1.57bn Pan-Borneo 5.00 Highway (Sarawak) (PBH) package. Gamuda is targeting to secure RM10bn p.a. worth of new contracts in 2017 and 2018 to 4.50 grow its order book. Its current record-high order book should 4.00 spur the long-term earnings growth of its construction division. Key risk to our call would be project delays Aug-14 Feb-15 Aug-15 Feb-16 Aug-16 Feb-17 Aug-17 Page 7 of 11

8 WCT (WCTHG MK) Target Price : RM2.46 Share Price as at 8 Sep 2017 : RM1.77 (RM) Aug-14 Feb-15 Aug-15 Feb-16 Aug-16 Feb-17 Aug-17 BUY WCT is one of our top BUYs among the mid-cap construction stocks with a 12-month target price of RM2.46 based on a 10% discount to our end-2017e RNAV. WCT has clinched RM1bn in new contracts to replenish its order book to about RM5.8bn currently. We believe WCT s prospects to garner more local contracts have improved after it secured its first MRT civil-works package. WCT is looking to bid for the ECRL and PBH packages. A share-price catalyst could be the major shareholder accelerating its plans to monetise its assets such as the potential injection of two malls into the planned listing of WCT REIT by mid This would reduce its high net gearing of above 0.86x currently. We look for a strong core EPS CAGR of 50% in E. Key risks to our call would be slower property sales and execution risks on its construction projects. HSS Engineers (HSS MK) Target Price : RM1.34 Share Price as at 8 Sep 2017 : RM1.13 (RM) Aug-16 Feb-17 Source: Bloomberg, Affin Hwang BUY We have a BUY call on HSS with a 12-month TP of RM1.34, based on a target CY18E PER of 17x, a discount to global peers' weighted average PER of 18x. HSS provides engineering consultancy and project management services for companies and governments. Some of its projects include MRT1 and MRT2, LRT Ampang Line extension, RAPID Pengerang, Westports, Kuantan Port and West Coast Highway. We like HSS for its long and established relationship with clients like Prasarana, MRT Corp, and myhsr, and its recent appointment as a consultant for ECRL. Being a well-positioned company with predominantly Bumiputera engineers allows them an upper hand in bidding for governmental projects. We believe it could potentially secure more contracts from existing clients. HSS usually earns an engineering fee of 2-5% on the total project value, while its only cost is manpower, which makes it highly profitable (FY16: 10% net profit margin). KLCON outperforms FBMKLCI The KL Construction (KLCON) Index has outperformed the FBMKLCI by 18% over the past three years, which we attribute to positive news flow on new contract awards. Over the past 12 months, AQRS was the top outperformer in our construction universe, outperforming the FBM KLCI by 99%. The current 12-month forward PER of 15.9x for the KLCON Index is above the long-term mean PER of 13.6x, while the current PBR of 1.49x is above the long-term mean PBR of 1.36x. This is justified, in our view, by the current cyclical upturn for the sector with good new contract procurement prospects to drive strong earnings growth. Page 8 of 11

9 Fig 13: KL Construction Index vs FBMKLCI Index performance Source: Bloomberg Fig 14: Construction stocks relative performance vs. FBMKLCI Source: Bloomberg *HSS was listed only on Aug 26, 2016 Page 9 of 11

10 Fig 15: KL Construction Index 12-month-forward PER Source: Bloomberg Fig 16: KL Construction Index 12-month-forward PBR Source: Bloomberg Key risks The key risks to our Overweight view on the construction sector would be 1) higher building material and labour costs, which would erode profit margins; 2) project execution risks; and 3) delays in the implementation of new infrastructure projects. When a report covers six or more subject companies please access important disclosures for Daiwa Capital Markets Hong Kong Limited at or contact your investment representative or Daiwa Capital Markets Hong Kong Limited at Level 26, One Pacific Place, 88 Queensway, Hong Kong. Page 10 of 11

11 Equity Rating Structure and Definitions BUY Total return is expected to exceed +10% over a 12-month period HOLD Total return is expected to be between -5% and +10% over a 12-month period SELL Total return is expected to be below -5% over a 12-month period NOT RATED Affin Hwang Investment Bank Berhad does not provide research coverage or rating for this company. Report is intended as information only and not as a recommendation The total expected return is defined as the percentage upside/downside to our target price plus the net dividend yield over the next 12 months. OVERWEIGHT Industry, as defined by the analyst s coverage universe, is expected to outperform the KLCI benchmark over the next 12 months NEUTRAL Industry, as defined by the analyst s coverage universe, is expected to perform inline with the KLCI benchmark over the next 12 months UNDERWEIGHT Industry, as defined by the analyst s coverage universe is expected to under-perform the KLCI benchmark over the next 12 months This report is intended for information purposes only and has been prepared by Affin Hwang Investment Bank Berhad (14389-U) ( the Company ) based on sources believed to be reliable. However, such sources have not been independently verified by the Company, and as such the Company does not give any guarantee, representation or warranty (express or implied) as to the adequacy, accuracy, reliability or completeness of the information and/or opinion provided or rendered in this report. Facts, information, views and/or opinion presented in this report have not been reviewed by, may not reflect information known to, and may present a differing view expressed by other business units within the Company, including investment banking personnel. Reports issued by the Company, are prepared in accordance with the Company s policies for managing conflicts of interest arising as a result of publication and distribution of investment research reports. Under no circumstances shall the Company, its associates and/or any person related to it be liable in any manner whatsoever for any consequences (including but are not limited to any direct, indirect or consequential losses, loss of profit and damages) arising from the use of or reliance on the information and/or opinion provided or rendered in this report. Any opinions or estimates in this report are that of the Company, as of this date and subject to change without prior notice. Under no circumstances shall this report be construed as an offer to sell or a solicitation of an offer to buy any securities. The Company and/or any of its directors and/or employees may have an interest in the securities mentioned therein. The Company may also make investment decisions or take proprietary positions that are inconsistent with the recommendations or views in this report. Comments and recommendations stated here rely on the individual opinions of the ones providing these comments and recommendations. These opinions may not fit to your financial status, risk and return preferences and hence an independent evaluation is essential. Investors are advised to independently evaluate particular investments and strategies and to seek independent financial, legal and other advice on the information and/or opinion contained in this report before investing or participating in any of the securities or investment strategies or transactions discussed in this report. Third-party data providers make no warranties or representations of any kind relating to the accuracy, completeness, or timeliness of the data they provide and shall not have liability for any damages of any kind relating to such data. The Company s research, or any portion thereof may not be reprinted, sold or redistributed without the consent of the Company. The Company, is a participant of the Capital Market Development Fund-Bursa Research Scheme, and will receive compensation for the participation. This report is printed and published by: Affin Hwang Investment Bank Berhad (14389-U) A Participating Organisation of Bursa Malaysia Securities Berhad 22nd Floor, Menara Boustead, 69, Jalan Raja Chulan, Kuala Lumpur, Malaysia. T : F : research@affinhwang.com Page 11 of 11

CY18E CY17E CY18E CY17E CY17E CY17E

CY18E CY17E CY18E CY17E CY17E CY17E Chinese investment boon We remain Overweight on the Malaysian Construction Sector given the positive outlook on contract awards in 2H17. But we have moderated our bullish stance following the downgrade