Construction (Overweight )

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1 Construction (Overweight ) HLIB Research PP 9484/12/2012 (031413) INDUSTRY INSIGHT 15 May 2017 The rail deal Highlights Mega rail projects on the cards. We have identified 4 mega rail projects that will be rolled out over the next 2-3 years. These include the East Coast Rail Link (ECRL), KL-Singapore High Speed Rail (HSR), Gemas-JB Electrified Double Track (EDT) and MRT3 Circle Line. Collectively, these mega rail projects will have a total cost of RM171bn. ECRL: The eastern link. The 600km ECRL (RM55bn) will link Kelantan, Terengganu, Pahang and Selangor. Financing of will come from EXIM Bank of China while CCCC will lead the construction works. SPAD has given its conditional approval for the ECRL which is now undergoing a 3 month public inspection. Final approval is targeted for June and construction is to begin in July. HSR: 2 nations, 1 journey. In Dec 2016, Malaysia and Singapore inked a bilateral agreement to implement the 350km HSR. The JDP has been appointed and tenders for the asset company will be called by year end while the infra works are expected in 1Q18. Media reports have placed the HSR s cost at RM60bn. Gemas-JB EDT: The final stretch. The Gemas-JB section (191km) is the final EDT stretch from the north to s outh of the Peninsular. A consortium of 3 state owned Chinese contractors was awarded the RM9bn job in Oct Work has yet to start due to issues with the state authorities. MRT3: Orbital link. Also dubbed the Circle Line, MRT3 will largely be underground, providing interchange stations with other radial rail lines (wheel and spooks concept). Currently at a feasibility study stage, the 45-48km MRT3 is said to cost RM50bn. Jeremy Goh, CFA pwgoh@hlib.hongleong.com.my (603) KLCON Index (341.7 pts) Pts KLCON (LHS) KLCI (RHS) May-16 Jul-16 Oct-16 Dec-16 Feb-17 May-17 Stock Rating Price Target Gamuda BUY IJM BUY MRCB Under Review 1.73 n.a. GKent BUY Pts Risks Rating A pull out of Chinese investments and/or funding would impact some of these mega rail projects (e.g. ECRL and Gemas -JB EDT). Maintain OVERWEIGHT While the bulk of these mega rail projects will be led by foreign contractors, we estimate that 39% could be undertaken by locals, potentially generating RM67bn worth of job flows. The significance of these mega rail projects to the construction sector should not be underestimated. To illustrate, domestic job wins to listed contracts hit a high of RM28bn in 2012 and RM56bn in 2016 when the MRT1 and MRT2 was rolled out. Stock Picks Gamuda: Strong track record in rail jobs such as the Kaohsiung MRT, Northern EDT, MRT1 and MRT2. Targets to add RM10bn to orderbook over the next 1-2 years from these rail jobs. GKent: Only local player with expertise in rail related systems. Has experience with Ampang LRT extension systems, LRT3 PDP and MRT2 track works. IJM: Beneficiary of ECRL via 60% stake in Kuantan Port and 20% stake in MCKIP (industrial park). ECRL will have a station at Kuantan Port while MCKIP is located 12km away. MRCB: In negotiations to develop a transport terminal for the HSR at Bandar Malaysia. Can leverage on its track record in Transit Oriented Developments (TODs). Page 1 of May 2017

2 Prelude The rail deal History of mega rail projects. Several mega rail projects have been implemented in Malaysia over the past decade. Amongst these include the Electrified Double Track from Ipoh to Padang Besar (RM12.5bn) and from Seremban to Gemas (RM3.5bn). More urban rail networks were also constructed such as the LRT extension for both the Ampang and Kelana lines (RM7bn), LRT3 from Bandar Utama to Klang (RM9bn), MRT1 Sg Buloh to Kajang (SBK Line) (RM22bn) and MRT2 Sg Buloh to Serdang to Putrajaya (SSP Line) (RM32bn). More on the cards. Looking ahead, we have identified another 4 mega rail projects that are set to be rolled out over the next 2-3 years. Collectively, these 4 mega rail jobs will have a staggering cost of RM171bn with total length of 1,189km. These include the East Coast Rail Link (ECRL), KL-Singapore High Speed Rail (HSR), Gemas-JB Electrified Double Track (EDT) and MRT3 Circle Line. While work has yet to commence for these 4 mega rail projects, most of them are at a pretty advanced planning stage to be rolled out. For example, (i) the main construction contract for the ECRL and Gemas-JB EDT has been awarded to Chinese contractors, (ii) both Malaysia and Singapore have inked a bilateral agreement for the HSR and (iii) feasibility studies are underway for the MRT3. RM86bn worth of rail projects implemented in the past decade 4 upcoming mega rail projects worth RM171bn to be rolled out Figure #1 Upcoming mega rail projects Rail Project Type Length (km) Cost (RM bn) East Coast Rail Link Electrified Double Track KL Singapore High Speed Rail High Speed Rail Gemas-JB Double Track Electrified Double Track MRT3 Circle Line Mass Rapid Transit Total 1, HLIB estimates Boost for contractors. Whilst the bulk of the works will be undertaken by foreigners, we conservatively estimate that these 4 mega rail projects could generate RM67bn (39% of contract value) worth of job flows to local contractors. To illustrate the significance of these mega rail projects, domestic contract awards to listed contractors hit a high of RM28bn in 2012 and RM56bn in 2016 when the MRT1 and MRT2 were rolled out respectively. potentially generating RM67bn worth of work for local contractors Figure #2 60 Domestic contract awards to listed contractors (RM bn) HLIB compilation from Bursa announcements Page 2 of May 2017

3 Highlights East Coast Rail Link Enabler for the east coa st. The East Coast Rail Link (ECRL) was first mooted during the tabling of Budget It has been identified as a high impact project aimed to stimulate economic growth in the East Coast Economic Region (ECER) which covers an area of over 60,000 sq km. This will be done by linking the eastern Peninsular states of Kelantan, Terengganu and Pahang to the western side at Selangor. At a cost of RM55bn, the ECRL will be the largest double tracking project in Malaysia. RM55bn ECRL will be the largest EDT project in M sia Figure #3 Proposed alignment of the ECRL Malaysia Rail Link Ea stern connectivity. With a total length of 600.3km (including 65.9km in spur lines), the ECRL will have 23 stations (4 provisional). The rail line will link key cities including Kota Bahru, Kuala Terengganu, Cherating, Kuantan and Gombak as well as industrial parks such as Kemaman, Kerteh and the upcoming Kuantan Port City. It will also connect to the KTM line in Wakaf Bahru and Mentakab and Kelana LRT in Gombak. Roughly 50km of the ECRL s alignment will involve hill and underground tunnelling with the single longest stretch from Gombak to Bentong (18km). End-to-end travel time via ECRL will take 4 hours compared to 10 hours currently via road. Connecting eastern states to Selangor in the west Page 3 of May 2017

4 Malaysia-China bilateral effort. Malaysia Rail Link (MRL), which comes under the Ministry of Finance (MoF), was recently set up to oversee the implementation of the ECRL. Upon completion, MRL will also be the operator and owner of the ECRL. In Nov 2016, a financing and EPC agreement was inked between Malaysia and China. Under the agreement, (i) the latter would provide financing for the project via Export-Import Bank of China and (ii) state owned China Communications Construction Company (CCCC) will lead the construction works. Subcontract opportunity for locals. While CCCC will lead the ECRL s construction, we see ample opportunities for local contractors to participate via subcontracts. Part of the mutual agreement between Malaysia and China on the ECRL is to ensure some degree of local participation by the former. Earlier in Jan, CCCC stated that it will call tenders soon for local contractors to participate in the ECRL. We understand that as much as 30% of the ECRL s value could be earmarked for local participation. If so, the ECRL would present RM16.5bn in potential job flows for local contractors to undertake. Timeline ahead. The ECRL has received conditional approval from the Land Public Transport Commission (SPAD) and is currently undergoing a 3-month (March to June) public inspection for its proposed alignment. Should all go well, the final alignment is expected to be approved by end June and construction tenders to begin in July. The entire project is targeted for completion by July 2024 over a 7 year construction period. Financing and construction led by China 30% of ECRL works could flow back to local contractors Undergoing public inspection; tenders in July Figure #4 Implementation timeline for ECRL Malaysia Rail Link KL-Singapore High Speed Rail 2 nations, 1 journey. The KL-Singapore High Speed Rail (HSR) is a strategic project between the governments of Malaysia and Singapore that aims to facilitate s eamless travel between the two capital cities. It will have a length of 350km, 335km of which will be in Malaysia and 15km in Singapore with 2 tracks in opposite directions. There will be a total of 8 stops at Singapore, Iskandar Puteri, Batu Pahat, Muar, Ayer Keroh, Seremban, Putrajaya and Bandar Malaysia. Both countries have agreed to construct and maintain the HSR within their own boundaries. This will be implemented by MyHSR Corp (a MoF subsidiary) and the Land Transport Authority (LTA) for Singapore. M sia and S pore agree to build HSR Page 4 of May 2017

5 Figure #5 Proposed alignment of the HSR Channel News Asia Speeding up travel time. Existing train travel between KL and Singapore currently takes up to 11 hours. This will be significantly reduced to just 90 minutes via HSR which is capable of hitting a maximum speed of 300km/h. Currently, the fastest mode of transportation between the CBD of both cities is via plane which has a point -to-point travel time of 4.2 hours. With the HSR, this will be shortened to just 2.5 hours. To facilities seamless travel, there are plans to co-locate the customs, immigration and quarantine (CIQ) checkpoints of both nations at Singapore, Puteri Iskandar and Bandar Malaysia. Fastest point-to-point travel via HSR Figure #6 Point-to-point travel time between KL and Singapore SPAD Plans gaining traction. In July 2016, Malaysia and Singapore signed a Memorandum of Understanding (MoU) for the HSR followed by a bilateral agreement in Dec. Subsequently in Feb 2017, the consortium comprising WSP Engineering, Mott MacDonald and Ernst & Young Advisory was appointed as the Joint Development Partner (JDP) for the HSR. As JDP, the consortium will provide project management, technical advice and develop safety standards for the HSR. It will also help MyHSR and LTA to prepare tender documents for the job. Checks on MyHSR s website reveal that apart from the JDP s appointment, 7 other contracts have also been dished out related to civil consultancy and technical advisory services. Bilateral agreement signed; JDP appointed Page 5 of May 2017

6 What lies ahead? Earlier this month, MyHSR CEO Mohd Nur Ismail said that the government will call for a tender by year end to set up a privately financed asset company (AssetsCo) for the HSR. AssetsCo will be responsible for the design, build, finance, operate and maintain the rolling stock and rail assets. Following this, infra tenders are expected to be called in 1Q18 with construction period until The HSR is targeted to commence operations in Tenders for AssetsCo by year end, infra by 1Q18 Figure #7 Implementation timeline for the HSR Channel News Asia Local participation required. While no official figures on the HSR s cost has been divulged, media reports have placed the price tag at RM60bn. This would translate into a per km cost of RM171m and based on this, the Malaysia stretch at 335km would be worth RM57bn. MyHSR CEO recently commented that there has been a lot of international interest to bid for the infra tenders. He also added that foreign bidders are required to ensure a 40% Bumiputera content so local businesses can benefit. Under this scenario, the HSR should then generate RM23bn worth of job flow opportunities for local contractors to undertake. RM23bn worth of contract opportunities for locals Gemas-JB Electrified Double Track Final part of the stretch. The idea of the Southern Electrified Double Track (EDT) from Seremban to Johor Bahru (JB) was mooted back in Construction of the first section from Seremban to Gemas, undertaken by India-based Ircon, began in 2008 and was completed in Implementation of the stretch from Gemas to JB would complete the Southern EDT which also means that the entire rail line from JB to Padang Besar in the northern Peninsular woul d be double tracked. The proposed Gemas-JB EDT will span 191km with 9 stations. Upon completion, travel time from JB to KL will be reduced from 6 to 3.5 hours. Gemas-JB is the final stretch of the EDT from north to south Figure #8 Past electrified double tracking projects in Malaysia Double Track Railway Contractor Completed Length Cost (year) (km) (RM bn) Rawang to Ipoh DRB-Hicom, Mitsui Sentul-Port Klang ext to Batu Caves YTL Corp Ipoh to Padang Besar MMC-Gamuda JV Seremban to Gemas Ircon Wikipedia Page 6 of May 2017

7 Figure #9 Proposed alignment of the Gemas-JB EDT The Star Chinese consortium appointed. Public inspection and feedback on the Gemas-JB EDT was conducted between Oct 2015 and Jan 2016 which received a 99.6% approval for the project. Subsequently in Oct 2016, the Ministry of Transport awarded the RM8.9bn project to a consortium of 3 Chinese state owned contractors China Railway Construction Corp (CRCC) (40%), China Railway Engineering Corp (CREC) (30%) and CCCC (30%). A ground breaking ceremony for the project was scheduled for Dec 2016 but this was delayed due to certain issues with the state authorities. Locals to participate. Although the Gemas-JB EDT will be undertaken by a Chinese consortium, CRCC has confirmed that the government would like to see 30% of the works awarded to local contractors. If so, this would create RM2.7bn worth of contracts for them to undertake. CRCC also mentioned that SIPP Railway (a private vehicle controlled by the Sultan of Johor) will be the consortium s local partner for the job, which will together appoint the respective local subcontractors. Consortium of 3 state owned Chinese contractors appointed 30% of the works to go to locals MRT3 Circle Line Circle line will be next. MRT3 is the last of the 3 lines that was proposed under Greater KL s MRT network. The MRT1 (SBK Line) will be fully operational in July 2017 while construction has just started for the MRT2 (SSP Line). Also dubbed as the Circle Line, MRT3 will integrate all the other radial rail lines from the MRT, LRT, Monorail and KTM via its orbital alignment, commonly known as the wheel and spokes concept. Still at the drawing board. In Sept 2016, MRT Corp mentioned that it had appointed and independent consultant to carry out an engineering feasibility study for the project which was supposed to be completed in 1Q17. Although the exact alignment has not been finalised, it is said to cover key areas such as Ampang Jaya, KLCC, Bukit Bintang, TRX, Bandar Malaysia, KL Ecocity, Pusat Bandar Damansara, Mont Kiara and Sentul. MRT Corp also stated that the MRT3 will be largely underground as it will pass through areas with many high rise buildings. Media reports have stated that the MRT3 could span 45-48km in length and cost RM50bn to build. MRT3 to provide interchange points to other radial rail lines Largely underground with estimated cost of RM50bn Page 7 of May 2017

8 Figure #10 Rough alignment of MRT Circle Line by SPAD SPAD Page 8 of May 2017

9 Rating & Stock Picks We believe that the rollout of these 4 mega rail projects will provide a significant boost to contract flows and hence maintain our OVERWEIGHT rating on the sector. Names that are expected to benefit from these mega rail projects include Gamuda (rail civil works), GKent (rail systems), IJM (Kuantan Port and MCKIP) and MRCB (TODs). Maintain OVERWEIGHT on construction Gamuda (BUY, TP: RM5.74) Having undertaken jobs such as the Kaohsiung MRT (RM400m), Northern EDT (RM6bn), MRT1 (RM22bn) and MRT2 (RM32bn), we view Gamuda one of the prime beneficiaries from the upcoming mega rail projects. Its strong delivery as PDP and tunnelling contractor for MRT1 and MRT2 should place it a polar position to reprise its role as both PDP and tunnelling contractor for the MRT3. With its track record in mountain tunnelling involving the Berapit Tunnel (Northern EDT) and Penchala Tunnel (SPRINT Highway), we believe Gamuda stands a good chance to participate in the ECRL which cuts through the mountainous Titiwangsa range. Excluding the MRT3, management is gunning to add RM10bn to its current orderbook (RM17bn including PDP) over the next 2 years which includes the ECRL and Gemas-JB EDT. Gamuda has extensive rail experience George Kent (BUY, TP: RM4.71) GKent is the only local player with expertise in rail related systems. It previously undertook the system works for the Ampang LRT extension (RM1.4bn). GKent is currently the PDP (JV with MRCB) for the LRT3 (RM9bn) and is also executing the track works (JV with CCCC) for the MRT2 (RM1bn). Management highlighted that it will continue to focus on system related works and is eyeing on all of the 4 upcoming mega rail projects. GKent has expertise in rail sytems IJM Corporation (BUY, TP: RM3.91) IJM has a 60% stake in Kuantan Port (KP) which is currently undergoing a 50% capacity expansion from 26m to 39m tonnes. As one of the ECRL s stations will be located at Kuantan Port, this should benefit them in terms of cargo throughput. This benefit will be more prevalent should the ECRL be extended all the way to Port Klang which is part of the long term plan. If this happens, cargo can be transported from Port Klang to Kuantan Port via rail and subsequently shipped out instead of having to make a loop around Singapore Port to reach the South China Sea. Apart from that, IJM also has a 20% effective stake in the Malaysia China Kuantan Industrial Park (MCKIP) which is located 12km from Kuantan Port. Implementation of the ECRL with a station in Kuantan Port should help to further encourage more industries to set up shop in MCKIP. Lastly, we also view IJM as a beneficiary of the mega rail projects via potential construction job flows. In terms of rail track record, IJM has undertaken jobs such as the Seremban-Gemas EDT (RM343m), MRT1 (RM975m) and MRT2 (RM1.5bn). IJM to benefit from ECRL via Kuantan Port and MCKIP Malaysian Resource Corporation (Under Review) We see MRCB as a beneficiary of the upcoming mega rail projects by virtue of its expertise in Transit Oriented Developments (TODs). MRCB s experience with TODs includes KL Sentral, PJ Sentral, Penang Sentral and Kwasa Damansara. It was recently reported that a consortium led by MRCB is in negotiations to build an integrated transport terminal in Bandar Malaysia to cater for the HSR. The transport terminal will provide an integration point between the HSR with the MRT2, MRT3, KTM and ERL. According to the masterplan, some 11-12% (55-60 acres) of Bandar Malaysia s land has been earmarked for the transport terminal. It was also reported that while IW H-CREC has been terminated as the master developer for Bandar Malaysia, this will not impact the transport terminal as MRCB is in direct negotiations with the MoF to implement the project. MRCB to leverage on its speciality in TOD Page 9 of May 2017

10 Figure #11 Stock Peer comparison Mkt Cap (RM m) Price (RM) Target (RM) Rating FYE P/E P/B ROE CY16 CY17 CY16 CY17 (CY17) Gamuda 13, BUY July % 2.2% IJM 12, BUY Mar % 1.9% MRCB 3, n.a. Under Review Dec % 0.5% GKent 1, BUY Jan % 3.0% HLIB estimates For companies with non-dec FYE, financials have been calendarised. Yield (CY17) Page 10 of May 2017

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As of 15 May 2017, Hong Leong Investment Bank Berhad has proprietary interest in the following securities covered in this report: (a) As of 15 May 2017, the analysts, Jeremy Goh, who prepared this report, have interest in the following securities covered in this report: (a) -. Published & Printed by Hong Leong Investment Bank Berhad (10209-W) Level 23, Menara HLA No. 3, Jalan Kia Peng Kuala Lumpur Tel / Fax Equity rating definitions BUY Positiv e recommendation of stock under coverage. Expected absolute return of more than +10% ov er 12-months, with low risk of sustained downside. TRADING BUY Positiv e recommendation of stock not under coverage. Expected absolute return of more than +10% ov er 6-months. Situational or arbitrage trading opportunity. HOLD Neutral recommendation of stock under coverage. Expected absolute return betw een -10% and +10% over 12-months, with low risk of sustained downside. TRADING SELL Negativ e recommendation of stock not under coverage. Expected absolute return of less than -10% ov er 6-months. Situational or arbitrage trading opportunity. SELL Negativ e recommendation of stock under coverage. High risk of negative absolute return of more than -10% ov er 12-months. NOT RATED No research coverage and report is intended purely for informational purposes. Industry rating definitions OVERWEIGHT The sector, based on weighted market capitalization, is expected to have absolute return of more than +5% ov er 12-months. NEUTRAL The sector, based on weighted market capitalization, is expected to have absolute return betw een 5% and +5% over 12-months. UNDERWEIGHT The sector, based on weighted market capitalization, is expected to have absolute return of less than 5% ov er 12-months. Page 11 of May 2017