We reiterate our OVERWEIGHT recommendation on the Construction
sector premised on the following investment merits: (i) anticipation of
the increasing news flows in the near-term, i.e. Cabinet approving the
RM25b KVMRT Line 2, conclusion of the RM6.0b WCE highway's financing,
feasibility study completion on High-Speed Rail, Langat 2 treatment
plant tender, award of PPP/PFI projects, (ii) development of the M&A
activities i.e. Selangor water assets, highways infrastructure such as
EDL, DUKE and Indian highways, (iii) commitment from the Government to
implement the "high impact but low import content” projects despite
potential review on mega project due to the weak fiscal position, and
(iv) undemanding valuation of big caps contractors. We advocate
investors to be "picky" at this juncture to selectively pick stocks that
have strong fundamentals and relatively certain to benefit from the
increasing news flows in the near-term. Hence, our Top Pick for now
remains GAMUDA. Gamuda is a prime beneficiary of the KVMRT2 and M&A
activities from the Selangor water asset. Meanwhile, we also like IJM as
it is a laggard big-cap contractor which should gravitate to our SOP
valuation after the financing of its 20%-owned WCE highway concluded.
Results review and outlook. Half of the stocks under our coverage reported weaker-than-expected 2Q13 results – mostly the small-mid cap stocks. Generally, it was due to (i) margin squeeze amidst higher costs, (ii) slower-than-expected progress billings, and (iii) unexpected events (i.e. Naim – revised Fiji contract value). Meanwhile, for the large-cap contractors (i.e. WCT and IJM), the results were largely in line. In fact, Gamuda (OP, TP: RM5.30) delivered its full-year FY13 (end-July) slightly above our expectation thanks to steady MRT progress. Going forward, we expect the contractors’ earnings in 2H13 to improve YoY driven by their healthy unbilled orderbook of more than RM30b. We also expect Gamuda to deliver another set of record earnings in its next financial year (FY14) as KVMRT1 progress is now starting to reach its active phase where the MRT tunnelling and the PDP scope’s financial progress stands at 18% and 12% respectively.
Mega projects re-sequencing? We are fully aware that the government may delay some of the projects due to the urgency to address the country’s fiscal position (i.e. narrowing surplus of current account, rising national debts, fiscal deficit position). Nonetheless, our economist is of the view that the government will not delay some of the high-impact projects, which will yield high multiplier effects such as KVMRT. In fact, the government has recently pointed that the KVMRT project will not be postponed.
Budget 2014 to announce value-for money projects. As the government is addressing the fiscal position, we are not expecting any new big mega projects to be announced in the Budget 2014. Nonetheless, the government indicated that it will announce “value-for-money spending initiatives” during the upcoming Budget 2014. This is based on the recent press report quoting the Second Finance Minister Datuk Seri Ahmad Husni Hanadzlah’s; “when we draw up the budget we look at both income and expenditure. However, in terms of expenditure, we are not just looking at a reduction, but also achieve high value for it.” We understand that the “high value expenditure that will achieve the high impact” could be projects that will only yield higher multiplier effects, namely MRT, and basic infrastructure projects. We also believe that the government will continue to announce PPP/PFI projects in Budget 2014 as these projects are not entirely funded by government but give higher multiplier effects to the economy. Furthermore, we also expect allocations for East Malaysia’s basic infrastructure projects to continue to be announced in the Budget 2014 as to accommodate the growing industrial activities in the region (i.e. SCORE).
Neutral on GST implementation. Should the government impose GST, there could be inflation risks due to higher building material prices and hence, margin compression. Nonetheless, we believe contractors have already fixed the price with the building material suppliers before the project started (based on quotations). Also, in terms of newly secured contracts, we believe, going forward, the master pay (clients either Government or Private) will absorb the additional costs arose from GST.
Positive news flows to drive the sector’s sentiment in the near term. All said, we believe the sector will still be driven by key important announcement in the next 3 – 6 months namely: (i) KVMRT Line 2 approval by the government, (ii) the conclusion of the WCE’s financing, (iii) the completion of feasibility study on High Speed Rail, (iv) Langat 2 awards, (v) basic infrastructure jobs, mainly in the Borneo region, and (v) PPP/PFI contract awards.
Construction stocks outperformed the benchmark index
KL Construction Index is still outperforming the benchmark KLCI Index, advanced 19.1% YTD against KLCI’s gain of 5.2% YTD. Our previous top pick for the 3Q13 Outlook, Muhibbah Engineering (+183.6% YTD), has outperformed Naim Holdings (+104.6% YTD). Investors continued to appreciate Muhibbah due to its bright prospects as a flexible contractor that could undertake various job scopes in various sectors, including infrastructure, marine-related, and O&G. Meanwhile, Naim’s share price has softened since our 3Q13 Strategy note which we believe is due to the negative surprise on its 2Q13 result in which its construction division unexpectedly suffered losses due to (i) revision of contract value in its Fiji Road Rehabilitation project by the client following technical and contractual agreement and: (ii) higher-than-expected costs aggravated by the resettlement projects in Murum. Meanwhile, Benalec and MRCB are the top losers so far in our construction space which we understand were dragged down by the negative sentiment on the stocks (i.e. MRCB: PJ Sentral court tussle, Benalec: delay on its Johor land deal).
Maintain OVERWEIGHT, focus on Big Caps namely GAMUDA and IJM. All in, we reiterate our OVERWEIGHT recommendation on the Construction sector premised on the following investment merits: (i) anticipation of the increasing news flows in the near-term, i.e. Cabinet approval on the RM25b KVMRT Line 2, conclusion of the RM6.0b WCE highway's financing, the completion of feasibility study on High-Speed Rail, Langat 2 treatment plant awards, award of PPP/PFI projects, (ii) development of the M&A activities i.e Selangor water assets, highways infrastructure such as EDL, DUKE and Indian highways, (iii) commitment from the Government to implement the "high impact but low import content” projects despite potential mega project review due to the nation's weak fiscal position, and (iv) undemanding valuation of big caps contractors. We advocate investors to be "picky" at this juncture to selectively pick stocks that have strong fundamentals and relatively certain to benefit from the increasing news flows in the near-term. Hence, our Top Pick for now remains GAMUDA.
Gamuda (OP; TP: RM5.30). We like Gamuda as (i) it has clearer earnings visibility with KVMRT (i.e. RM3.5b tunnelling project and PDP scope for the remainder packages), (ii) it has a brighter replenishment orderbook prospect for the next 10 years with the roll-out of KVMRT Line 2 and 3, (iii) anticipation of special dividend from the sale of its 40%-owned SPLASH (i.e. 30 – 35 sen/share), (iv) its valuation is still cheap where we think the stock should trade above its 5-year historical PER average of 16.1x due to its strong fundamentals and anticipation of special dividend. Two key announcement that should be closely watched in the near-term are: (i) KVMRT Line 2 approval from the Cabinet, and (ii) restructuring of Selangor’s water asset.
Meanwhile, we also like IJM (OP; TP: RM6.51) as it is highly expected that the WCE highway’s financing will be concluded soon. We believe IJM Corp will be the biggest beneficiary as: (i) the highway will top-up its orderbook to at least RM4.0b on its existing RM3.0b, (ii) its 62-% owned subsidiary, IJM Land is currently developing a new township worth RM11b GDV spanning over 1878ac in the Kota Kemuning area located next to the WCE highway, (iii) the highway will bring another stream of recurring income in the foreseeable future (estimate: 2016) to IJM as it effectively owns 38% of the highway operator, WCESB (i.e. direct stake of 20% of WCESB and 22% of KEuro). Once the WCE highway’s financing is concluded, we believe the stock should gravitate to our SOP valuation.
Besides Gamuda and IJM, for the overall stocks recommendation, we reiterate our OUTPERFORM calls on Muhibbah (TP: RM3.00), Naim Holdings (TP: RM4.45), Benalec (TP: RM1.94),and TRC Synergy (TP: RM0.75). Meanwhile, we are maintaining our MARKET PERFORM calls on WCT (TP: RM2.50), Eversendai (TP; RM1.52), and Kimlun (TP; RM1.93), MRCB (TP: RM1.59).
Risks to our sector calls include: (i) further delay on the Cabinet approval on MRT Line 2, (ii) unexpected negative announcement such as scrapping mega projects, (iii) absence of abovementioned positive news flows, (iii) rising building material prices, (iv) unexpected negative global event such as economic crisis.
Long-term orderbook replenishment prospect for contractors
As for the next 10 years, we see a lot of opportunities for contractors in terms of orderbook replenishment prospect. These contracts will come from the remaining ETP and 10MP projects which include:
Infrastructure - Railway. The government has so far shown great commitments in developing railway infrastructure. It has committed billions of Ringgit in railways including; double tracking, LRT extensions (RM7.0b) and MRT1 (RM23b). Going forward, we understand that the government will continue to expand and upgrade the country’s railway tracks. The projects, among others, are: MRT2 and MRT3 (both combined worth about RM60b), KL–Singapore High Speed Railway (RM30b), Southern Double Track (Gemas –JB) (RM8.0b), KVDT upgrades (RM850m), LRT3 extensions (RM5.0b), East Coast Region Railway (RM30b), Johor-Singapore RTS (RM3.0b), and KL Monorail extension (RM3.0b). All these projects amount to a total contract size of more than RM100b.
Infrastructure - Highway. At the same time, Malaysia is poised to expand the existing expressways. West Coast Expressway Sdn Bhd (WCESB) (80:20 between KEuro:IJM) been appointed as a concessionaire of the RM6.0b West Coast Expressway (WCE) spanning from Banting-Taiping while Ahmad Zaki Resources Bhd (AZRB) won the second circle highway of RM1.55b East Klang Valley Expressway (EKVE) highway. Moving forward, there will be more highways to be built especially in the Klang Valley such as Kinrara-Damansara Expressway (Kidex) (RM2.5b), SUKE (RM3.5b) and DASH (RM2.5b). In addition, we also understand that the government has already approved the RM16.0b upgrading of the 3000km Pan Borneo highway (Sabah to Sarawak).
Infrastructure – Water. It is widely reported that a water treatment plant will be built in Hulu Langat (Langat 2) to complete the Pahang-Selangor Raw Water Transfer that is currently on-going with 65% completion (tunnelling). The project is estimated to cost RM1.2b.
Mixed Development projects. To recap, there are few mixed development projects that are already in the pipeline such as Tun Razak Exchange (RM20b) and KWASA’s Rubber Research Institute land at Sungai Buloh (RM10b). Furthermore, WCT secured a package of earthwork in TRX worth RM169m in April 2013 vs. the total earthwork packages which has an estimated worth of RM1.2b – RM1.5b.
Source: Kenanga
Results review and outlook. Half of the stocks under our coverage reported weaker-than-expected 2Q13 results – mostly the small-mid cap stocks. Generally, it was due to (i) margin squeeze amidst higher costs, (ii) slower-than-expected progress billings, and (iii) unexpected events (i.e. Naim – revised Fiji contract value). Meanwhile, for the large-cap contractors (i.e. WCT and IJM), the results were largely in line. In fact, Gamuda (OP, TP: RM5.30) delivered its full-year FY13 (end-July) slightly above our expectation thanks to steady MRT progress. Going forward, we expect the contractors’ earnings in 2H13 to improve YoY driven by their healthy unbilled orderbook of more than RM30b. We also expect Gamuda to deliver another set of record earnings in its next financial year (FY14) as KVMRT1 progress is now starting to reach its active phase where the MRT tunnelling and the PDP scope’s financial progress stands at 18% and 12% respectively.
Mega projects re-sequencing? We are fully aware that the government may delay some of the projects due to the urgency to address the country’s fiscal position (i.e. narrowing surplus of current account, rising national debts, fiscal deficit position). Nonetheless, our economist is of the view that the government will not delay some of the high-impact projects, which will yield high multiplier effects such as KVMRT. In fact, the government has recently pointed that the KVMRT project will not be postponed.
Budget 2014 to announce value-for money projects. As the government is addressing the fiscal position, we are not expecting any new big mega projects to be announced in the Budget 2014. Nonetheless, the government indicated that it will announce “value-for-money spending initiatives” during the upcoming Budget 2014. This is based on the recent press report quoting the Second Finance Minister Datuk Seri Ahmad Husni Hanadzlah’s; “when we draw up the budget we look at both income and expenditure. However, in terms of expenditure, we are not just looking at a reduction, but also achieve high value for it.” We understand that the “high value expenditure that will achieve the high impact” could be projects that will only yield higher multiplier effects, namely MRT, and basic infrastructure projects. We also believe that the government will continue to announce PPP/PFI projects in Budget 2014 as these projects are not entirely funded by government but give higher multiplier effects to the economy. Furthermore, we also expect allocations for East Malaysia’s basic infrastructure projects to continue to be announced in the Budget 2014 as to accommodate the growing industrial activities in the region (i.e. SCORE).
Neutral on GST implementation. Should the government impose GST, there could be inflation risks due to higher building material prices and hence, margin compression. Nonetheless, we believe contractors have already fixed the price with the building material suppliers before the project started (based on quotations). Also, in terms of newly secured contracts, we believe, going forward, the master pay (clients either Government or Private) will absorb the additional costs arose from GST.
Positive news flows to drive the sector’s sentiment in the near term. All said, we believe the sector will still be driven by key important announcement in the next 3 – 6 months namely: (i) KVMRT Line 2 approval by the government, (ii) the conclusion of the WCE’s financing, (iii) the completion of feasibility study on High Speed Rail, (iv) Langat 2 awards, (v) basic infrastructure jobs, mainly in the Borneo region, and (v) PPP/PFI contract awards.
Construction stocks outperformed the benchmark index
KL Construction Index is still outperforming the benchmark KLCI Index, advanced 19.1% YTD against KLCI’s gain of 5.2% YTD. Our previous top pick for the 3Q13 Outlook, Muhibbah Engineering (+183.6% YTD), has outperformed Naim Holdings (+104.6% YTD). Investors continued to appreciate Muhibbah due to its bright prospects as a flexible contractor that could undertake various job scopes in various sectors, including infrastructure, marine-related, and O&G. Meanwhile, Naim’s share price has softened since our 3Q13 Strategy note which we believe is due to the negative surprise on its 2Q13 result in which its construction division unexpectedly suffered losses due to (i) revision of contract value in its Fiji Road Rehabilitation project by the client following technical and contractual agreement and: (ii) higher-than-expected costs aggravated by the resettlement projects in Murum. Meanwhile, Benalec and MRCB are the top losers so far in our construction space which we understand were dragged down by the negative sentiment on the stocks (i.e. MRCB: PJ Sentral court tussle, Benalec: delay on its Johor land deal).
Maintain OVERWEIGHT, focus on Big Caps namely GAMUDA and IJM. All in, we reiterate our OVERWEIGHT recommendation on the Construction sector premised on the following investment merits: (i) anticipation of the increasing news flows in the near-term, i.e. Cabinet approval on the RM25b KVMRT Line 2, conclusion of the RM6.0b WCE highway's financing, the completion of feasibility study on High-Speed Rail, Langat 2 treatment plant awards, award of PPP/PFI projects, (ii) development of the M&A activities i.e Selangor water assets, highways infrastructure such as EDL, DUKE and Indian highways, (iii) commitment from the Government to implement the "high impact but low import content” projects despite potential mega project review due to the nation's weak fiscal position, and (iv) undemanding valuation of big caps contractors. We advocate investors to be "picky" at this juncture to selectively pick stocks that have strong fundamentals and relatively certain to benefit from the increasing news flows in the near-term. Hence, our Top Pick for now remains GAMUDA.
Gamuda (OP; TP: RM5.30). We like Gamuda as (i) it has clearer earnings visibility with KVMRT (i.e. RM3.5b tunnelling project and PDP scope for the remainder packages), (ii) it has a brighter replenishment orderbook prospect for the next 10 years with the roll-out of KVMRT Line 2 and 3, (iii) anticipation of special dividend from the sale of its 40%-owned SPLASH (i.e. 30 – 35 sen/share), (iv) its valuation is still cheap where we think the stock should trade above its 5-year historical PER average of 16.1x due to its strong fundamentals and anticipation of special dividend. Two key announcement that should be closely watched in the near-term are: (i) KVMRT Line 2 approval from the Cabinet, and (ii) restructuring of Selangor’s water asset.
Meanwhile, we also like IJM (OP; TP: RM6.51) as it is highly expected that the WCE highway’s financing will be concluded soon. We believe IJM Corp will be the biggest beneficiary as: (i) the highway will top-up its orderbook to at least RM4.0b on its existing RM3.0b, (ii) its 62-% owned subsidiary, IJM Land is currently developing a new township worth RM11b GDV spanning over 1878ac in the Kota Kemuning area located next to the WCE highway, (iii) the highway will bring another stream of recurring income in the foreseeable future (estimate: 2016) to IJM as it effectively owns 38% of the highway operator, WCESB (i.e. direct stake of 20% of WCESB and 22% of KEuro). Once the WCE highway’s financing is concluded, we believe the stock should gravitate to our SOP valuation.
Besides Gamuda and IJM, for the overall stocks recommendation, we reiterate our OUTPERFORM calls on Muhibbah (TP: RM3.00), Naim Holdings (TP: RM4.45), Benalec (TP: RM1.94),and TRC Synergy (TP: RM0.75). Meanwhile, we are maintaining our MARKET PERFORM calls on WCT (TP: RM2.50), Eversendai (TP; RM1.52), and Kimlun (TP; RM1.93), MRCB (TP: RM1.59).
Risks to our sector calls include: (i) further delay on the Cabinet approval on MRT Line 2, (ii) unexpected negative announcement such as scrapping mega projects, (iii) absence of abovementioned positive news flows, (iii) rising building material prices, (iv) unexpected negative global event such as economic crisis.
Long-term orderbook replenishment prospect for contractors
As for the next 10 years, we see a lot of opportunities for contractors in terms of orderbook replenishment prospect. These contracts will come from the remaining ETP and 10MP projects which include:
Infrastructure - Railway. The government has so far shown great commitments in developing railway infrastructure. It has committed billions of Ringgit in railways including; double tracking, LRT extensions (RM7.0b) and MRT1 (RM23b). Going forward, we understand that the government will continue to expand and upgrade the country’s railway tracks. The projects, among others, are: MRT2 and MRT3 (both combined worth about RM60b), KL–Singapore High Speed Railway (RM30b), Southern Double Track (Gemas –JB) (RM8.0b), KVDT upgrades (RM850m), LRT3 extensions (RM5.0b), East Coast Region Railway (RM30b), Johor-Singapore RTS (RM3.0b), and KL Monorail extension (RM3.0b). All these projects amount to a total contract size of more than RM100b.
Infrastructure - Highway. At the same time, Malaysia is poised to expand the existing expressways. West Coast Expressway Sdn Bhd (WCESB) (80:20 between KEuro:IJM) been appointed as a concessionaire of the RM6.0b West Coast Expressway (WCE) spanning from Banting-Taiping while Ahmad Zaki Resources Bhd (AZRB) won the second circle highway of RM1.55b East Klang Valley Expressway (EKVE) highway. Moving forward, there will be more highways to be built especially in the Klang Valley such as Kinrara-Damansara Expressway (Kidex) (RM2.5b), SUKE (RM3.5b) and DASH (RM2.5b). In addition, we also understand that the government has already approved the RM16.0b upgrading of the 3000km Pan Borneo highway (Sabah to Sarawak).
Infrastructure – Water. It is widely reported that a water treatment plant will be built in Hulu Langat (Langat 2) to complete the Pahang-Selangor Raw Water Transfer that is currently on-going with 65% completion (tunnelling). The project is estimated to cost RM1.2b.
Mixed Development projects. To recap, there are few mixed development projects that are already in the pipeline such as Tun Razak Exchange (RM20b) and KWASA’s Rubber Research Institute land at Sungai Buloh (RM10b). Furthermore, WCT secured a package of earthwork in TRX worth RM169m in April 2013 vs. the total earthwork packages which has an estimated worth of RM1.2b – RM1.5b.
Source: Kenanga
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