Construction - Plenty Of Room For Improvement From 2Q14

We maintain our OVERWEIGHT call on the construction sector despite a muted 2Q14. We believe the current strong momentum of activities in the sector will sustain, backed by the Klang Valley MRT and other mega projects, potentially driving sector earnings growth in the medium term. Our top themes and corresponding stock picks are the Klang Valley MRT project (Gamuda), piling (Pintaras) and public housing (Protasco). 

Just scraping through in 2Q14.  While almost all construction companies delivered their numbers, we see a lack of spark in their latest quarterly results. Of the nine construction companies under our coverage universe which reported results, eight (89%) came in within our projections and one (11%) missed our expectations. None actually beat our numbers. 

Maintain OVERWEIGHT. Despite a muted 2Q14, we maintain our OVERWEIGHT stance on the construction sector as we believe the current strong momentum of activities in the sector will sustain, potentially driving sector earnings growth over the medium term. We are unperturbed by the construction resources to be disengaged from the MYR23bn Line 1 of the Klang Valley MRT project upon its completion in mid-2015. We believe they will find their homes in the MYR25bn Line 2 of the Klang Valley MRT project (scheduled to start work in 1Q16), or a host of other mega projects that have already hit the ground, particularly the MYR89bn Refinery And Petrochemical Integrated Development (RAPID) project in Pengerang, Johor, the MYR5bn West Coast Expressway (WCE) as well as various public housing projects backed by the MYR1bn Housing Facilitation Fund. 

Top themes and corresponding stock picks. We believe picking the right themes is crucial to a winning investment strategy in construction stocks. This is subject to the availability of meaningful proxies to the themes, and decent upside to our valuations for the proxies. Our screening produces three top themes with meaningful proxies with decent upside to our valuations. They are: i) the Klang Valley MRTproject - Gamuda (GAM MK, BUY, FV: MYR5.61), ii) piling – PintarasJaya (PINT MK, BUY, FV: MYR4.92), and iii) public housing – Protasco (PRTA MK, BUY, FV: MYR2.43).

 

 

Plenty Of Room For Improvement From 2Q14 
Just scraping through in 2Q14. While almost all construction companies delivered their numbers, we see a lack of spark in their latest quarterly results. Of the nine construction companies under our coverage universe which reported results, eight (89%) came in within our projections and one (11%) missed our expectations. None actually beat our numbers (see Figure 1). The company that disappointed, namely, Eversendai (EVSD MK, NEUTRAL, FV: MYR1.06), failed to meet our forecast due to its inability to immediately recover variation order claims. While quarterly numbers of IJM Corp (IJM MK, BUY, FV: MYR7.90), Kimlun (KCB MK, BUY, FV: MYR1.88), Protasco (PRTA MK, BUY, FV: MYR2.43) and Hock Seng Lee (HSL MK, NEUTRAL, FV: MYR2.06) technically fell short on an annualised basis, we regarded their results as in line, as we expect them to report stronger quarters ahead. We cut our FY14/15F forecasts for Eversendai as we now assume it will take a longer time for it to fully recover those variation order claims.

 

 

Maintain OVERWEIGHT. Despite a muted 2Q14, we maintain our OVERWEIGHT stance on the construction sector as we believe the sector’s current strong momentum of activities will be sustained, potentially driving medium-term sector earnings growth. We are unconcerned by the construction resources to be disengaged from the MYR23bn Line 1 of the Klang Valley MRT project upon completion in mid-2015. We believe they will find their homes in the MYR25bn Line 2 of the Klang Valley MRT project (scheduled to start work in 1Q16), or a host of other mega projects that have already hit the ground, particularly the RAPID project in Pengerang, Johor, the MYR5bn WCE and various public housing projects backed by the MYR1bn Housing Facilitation Fund. 

Line 2 of Klang Valley MRT. MRT Co was quoted by The Starin May 2014 as saying that “the Cabinet already approved the Line 2 proposal in February (2014) and now it is up to the Government when they want to officially announce the rollout”. The 3-line Klang Valley MRT project is the main pillar of support to the current upcycle of the local construction sector given: i) the sheer size of MYR73bn, ii) that it reverberates along the entire value chain of the construction sector, giving rise to job 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. RAPID.We believe the implementation of the RAPID has finally hit “escape velocity”, as evidenced by a flurry of contracts awarded recently (see Figures 2 & 3). For RAPID jobs, construction companies’ focus is now on civil works for processing plants (which can run into almost MYR1bn each), after the recent award of the second and last earthworks package and the access roads package.

 

 

WCE. The Government appointed an IJM-Kumpulan Europlus consortium in May as the turnkey contractor for the construction of the WCE for MYR5bn. Physically, the new 316km highway (224km tolled and 92km toll-free) from Banting in Selangor to Taiping in Perak, will be implemented in two parts. The first part comprising Sections 3, 4, 5, 8 and 9 with a total value of MYR2.8bn (we believe to be funded by commercial loan) has been awarded to IJM (IJM MK, BUY, FV: MYR7.90). The second part comprising Sections 1, 2, 6, 7, 10 and 11 with a total value of MYR2.2bn (we believe to be funded by government soft loan) will be opened for bidding for all qualified contractors (including IJM) over the immediate term.

Public housing.This segment has become a new growth area thanks to the MYR1bn allocated to the Housing Facilitation Fund under the 2014 Budget. Among the key public housing schemes that draw on the fund (so that buyers can enjoy a 10-20% discount on market prices) are the 1Malaysia Public Housing Programme (PR1MA) and 1Malaysia Civil Servants’ Housing Programme (PPA1M) (see Figure 4). PR1MA promotes home ownership in “key urban centres” at affordable prices (defined as MYR100k-400k) for the middle-income group (defined as households with monthly income of MYR2,500-7,500). Likewise, PPA1M promotes affordable housing for government servants in Putrajaya, the federal administrative centre.

 

Sector risks. These include: i) the Government dialing back on its commitment and timeliness in the implementation of Lines 2 and 3 of the Klang Valley MRT project (which will result in a sector de-rating in our view, as the Klang Valley MRT project is the main pillar of support to the current construction upcycle), ii) constraints on construction resources, and iii) an escalation in input costs.

Top themes and corresponding stock picks. We believe picking the right themes is crucial to a winning investment strategy in construction stocks. This is subject to the availability of meaningful proxies to the themes, and decent upside to our valuations for the proxies. Our screening produces three top themes with meaningful proxies that exhibit decent upside to our valuations. They are: i) the Klang Valley MRT project – Gamuda, ii) piling – Pintaras Jaya, and iii) public housing – Protasco. We believe the best proxy to the Klang Valley MRT project is Gamuda, as it has secured, via a 50:50 MMC-Gamuda joint venture (JV), the choice parts of Line 1 of
the project (and most likely Lines 2 and 3 as well).

Gamuda plays the roles of: i) the project delivery partner (PDP) for the elevated portion, from which the JV earns a PDP fee amounting to 6% of the elevated portion’s contract value of about MYR14bn, and ii) the main contractor of the tunnelling portion that the JV is involved with, for which we assume a margin of 12% over the corresponding contract value of MYR8.3bn.

The prospects for the piling segment are strong, backed by: i) the MYR73bn Klang Valley MRT project, ii) a proliferation of high-rise developments amid rising land scarcity in prime locations that require extension piling, and iii) the chronic shortage of piling capacity in the market, which should boost piling rates. We believe the best proxy to the piling segment is Pintaras Jaya, given its advantages over its rivals including its: i) full range of piling machines, tools and accessories, ii) in-depth knowledge of ground conditions, and iii) ability to secure cash discounts for key inputs.

We believe margins from public housing projects are attractive given: i) that the contracts are awarded largely on a directly-negotiated basis, and ii) the inherently relatively low execution risks for these simpler 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.

Source: RHB