RHB Cautiously Optimistic On Construction in 2022

RHB Investment Research remains cautiously optimistic of the construction sector’s recovery prospects in 2022 underpinned by a broad rebound in work productivity post-pandemic, as construction companies should remain busy playing catch-up on job backlogs over the coming quarters.

It said that its near-term earnings trajectory may be somewhat held back by margin pressures arising from an inflationary building material cost environment, potentially persisting for a while longer before mean-reverting in 2H22F.

“Against this risk-reward, valuations for the sector seem fair, with the KLCON index trading close to its 10-year mean, at 12.6x forward P/E. A sector re-rating may be driven by an earlier-than-expected rollout of fresh mega projects such as the much-awaited Mass Rapid Transit Line 3 (MRT3),” RHB said

RHB said that the construction companies are set to see a much-needed reprieve from the drawn-out pandemic ordeal in 2020-2021, with the industry being one of the worst-hit amid the stop-start operating environment compelled by recurrent lockdown restrictions.

The research house said that the Impact on sector earnings has been visible, given the disruption in progress billings, coupled with rigidly fixed costs driving negative operating leverage – with six out of seven quarterly reporting seasons falling below our expectations, and only one coming in-line in 4Q20.

Moving forward, however, barring any unforeseen resurgences of COVID-19 infections, RHB said that the worst has likely passed, with the easing inactive cases giving rise to relaxation in SOP restrictions on project sites since August – contingent upon vaccination coverage for the workforce.

As such, several construction companies have since guided for a broad normalisation in work productivity to set in from 4Q21, with optimism for a full-year recovery in operations come 2022

It said that although downside risks to job execution affecting progress billings appear to be retreating, operating margins may take longer to recover to pre-pandemic levels, given that contractors have been facing input cost pressures since 1H21, stemming from the sharp price hike for various building materials, amid an inflationary environment.

RHB said that in particular, domestic prices for steel bars have risen as much as 50% to >MYR3,000/tonne vs the pre-pandemic historical average, before seeing signs of easing in 4Q21. “Cement prices have also jumped by 25% QoQ in 4Q21, based on our channel checks, following the recent surge in thermal coal feedstock prices. As the presence of cost pass-through mechanisms varies across individual contracts, we believe the recovery trajectory for construction sector earnings may remain partially restrained by raw material cost escalation in 1H22, before a more significant pick-up in 2H22,” it said.

It said that overall, although earnings prospects for the sector look to be stabilising post-pandemic, the investment case appears to be capped with the KLCON trading at mid-cycle valuations – close to its 5-year mean P/E of 13x.

It said that this despite share prices still trending below pre-pandemic levels – likely reflecting the more progressive rather than the imminent pace in aggregate earnings recovery next year.

Meanwhile, new developments relating to the rollout of the much-anticipated fresh mega projects such as MRT3 has remained subdued thus far, with announcements under the Budget 2022/12th Malaysia Plan largely centred upon the continuation of existing infrastructure projects in the pipeline, such as the East Coast Rail Link (ECRL) and Pan-Borneo Highway, amid fiscal constraints faced by the Government.

RHB said that this should continue to cap market sentiment on the sector in the near term, we believe, given the lack of fresh re-rating catalysts against current valuations.

“While we do not rule out the possibility of more positive developments, such as the possible revival of MRT3 alongside the KL-Singapore High-Speed Rail (HSR) projects – the latter being recently touted again in the media – happening in 2022, we believe any meaningful news flow pertaining to the rollout of these projects are more likely to transpire from mid-2022, given their sizeable funding considerations and potential changes in deal structure to be ironed out,” it said

On stock picks, it said that given its cautious stance on the sector, due to the uncertainty in large-scale infrastructure project rollouts posing risks to job replenishment prospects, RHB  continues to favour companies with robust existing order books to weather an overhang, while also possessing healthy balance sheets to gear up for future public job tenders.

It said that its preferred picks remain Sunway Construction  Group Bhd (SCGB MK, BUY, TP: MYR1.81) and Kerjaya Prospek Bhd (KPG MK, BUY, TP: MYR1.62).

Its key upside/downside risks to our sector call would revolve around the acceleration/deceleration in order book replenishments, potential surprises surrounding the timeline of public infrastructure project rollouts, as well as raw material cost trends.

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