Better visibility on contract flows post-GE 15 and better political stability after the upcoming state elections foreseen, along with the importance of the Mass Rapid Transit (MRT) 3 and the revival of the High-Speed Rail (HSR), stronger balance sheets (more apparent with the larger-cap stocks Gamuda and IJM) enabling a strong appetite for private finance initiative (PFI) projects; and compelling sector valuations at 11x CY24F P/E and 0.9x CY24F P/BV (-1 s.d. below mean since 2005), on the back of a 2-year EPS CAGR of 13% (CY22-24F) has resulted in Malaysia Construction and Material Sector being lifted from Neutral to Overweight, CGSCIMB said today (May 26).
This is amidst downside risks to their sector call are political instability and escalating raw material costs.
The firm has raised YTL, MCement, Sunway and Muhibbah stocks to Add with higher TP based on their earnings forecasts which have been adjusted across the expectations. These stocks have been lifted from Hold to Add with higher TPs: YTL (TP: RM1.00), MCement (TP: RM3.97), Sunway (TP: RM2.21) and Muhibbah (TP: RM0.90).
While CGSCIMB’S rating on YTL is largely premised on the higher TP for YTL Power, they believe its presence in industrial warehouses is gaining traction while its cement and construction business are key beneficiaries of a revival in construction spending.
Muhibbah is a prime beneficiary of a resurgence in global travel, particularly Chinese tourists, from its 21% stake in the Cambodian airport concession; its recent wins have been Petronas-driven (totaling RM678m from three projects from 2H22 to date).
A Higher TP for Gamuda, WCT and HSS
The firm has lifted their SOP-based TP for Gamuda to RM5.58 from RM4.69 to factor in its RM21bn orderbook and RM8bn in new order wins in FY23F. The SOP-based TP for WCT is RM0.71 from RM0.59. Its biggest catalyst is the Subang Airport Regeneration Plan, which is awaiting approval from the Ministry of Finance; this should pave the way for up to RM2bn worth of new orders and provide it with a recurring revenue stream, in their view.
The DCF-based TP for HSS is RM0.81 (WACC: 9.4%, TG: 4.5%; from end-CY24F P/E of 14.5x).
Sector top picks
CGS CIMB’s top picks for the sector are Gamuda, Suncon (new initiation), Sunway and YTL.
“We like Gamuda for its successful diversification to Australia and the next leg of growth to double its orderbook and presales. Suncon’s track record for both public and private sector projects looks impeccable to us, and the strong pipeline of projects from parent company Sunway Berhad has enabled it to achieve consistent new orders of RM2bn p.a. since FY18. In our view, YTL represents the best proxy to a HSR revival due to its experience and track record with rail projects,” CGSCIMB said in a note today.
The factors surrounding the positive outlook stems from the highest ever development expenditure in 2023 under Budget 2023 (which was retabled in Feb 2023 by the new unity government), the amount earmarked for development expenditure was RM96.5bn.
This translates into a quarter of the total budget and may provide some indication of the potential direction of the sector post the upcoming state elections.
CGSCIM notes that this will be the country’s biggest development expenditure so far, where half of the total should go towards strengthening transport, trade and industry, energy and public utilities, agriculture, and environment.
Government debt-to-GDP remains elevated, in the firm’s view, the biggest impediment for the sector is the elevated federal government debt levels and contingent liabilities, which amount to RM1.5tr.
The debt-to-GDP ratio was 60.4% in Dec 2022, rising to 80.9% if contingent liabilities are included. This gives little headroom to allocate funding for construction projects with the ceiling set at 65%.
Malaysia’s statutory debt ceiling was raised from 55% to 60% in Aug 2020, and then again from 60% to 65% in 2021, because of more borrowings during the pandemic.
Hence, the firm expects more projects going forward to have PFI/public-private partnership (PPP) elements, and contractors with stronger balance sheets should benefit.
Steel prices are descending from the 2022 peaks
Steel prices have abated from the peak c.RM3,470/mt seen in 1Q22-2Q22 and are currently trading at c.RM3,000/mt. The higher steel prices had a negative impact on smaller contractors, which lack economies of scale, and also contractors which had a higher percentage of orderbook to building jobs.
With steel prices appearing to be more stable now, we believe that this would give contractors better visibility in terms of costing when bidding for new jobs.
Cement prices bumped up in 1Q23 Cement prices rose to RM410/mt in early-2023 from RM370/mt. After rebates, the average selling price is about RM370/MT. Given the subdued property market and key mega projects such as MRT 3 not taking off yet, CGSCIMS expects cement prices to be stable for now.
Risk-reward Plus: Inexpensive valuations; muted earnings expectations
Expectations on the sector are widely muted and reflected in the valuations, which are trading at mean levels.
Net profit expectations also appear fairly muted, with an average increase of 5.3% in FY23F and 3.9% in FY24F for Bloomberg’s consensus’ earnings forecasts for our universe YTD, (consensus’ forecast changes have been more company specific vs. sector driven).
The firm upgraded the sector from Neutral to Overweight as they see a few catalysts unfolding for the rest of 2023F, which should lead to an eventual re-rating of the sector.
The new unity government brings new opportunities. Investors are warming up to the new unity government, where the focus is on transparent awarding of contracts based largely on merit.
Although the outcome of the upcoming state elections would be key, the higher development expenditure (up 34% yoy to RM96.5bn) under the Feb 2023 Budget is a sign that the government is focused on construction sector-led growth.
The eventual rollout of MRT 3 by 2HCY23F (or latest by 1QCY24F) costing at least RM45bn should provide orderbook replenishment opportunities for contractors, particularly those that have prior experience with MRT Lines 1 and 2, such as IJM, Suncon and WCT.
In addition, news flow on the revival of the HSR is gaining traction, and it has been reported that five companies (MMC, WCT, YTL, Berjaya and MRCB) have been shortlisted to undertake feasibility studies. Overseas project flows provide another growth avenue, but let’s be selective.
Expectations are for overseas project flows to be more apparent moving forward. The firm observed that contractors have been making conscious efforts to be less reliant on Malaysia’s public sector and slowing private sector projects by diversifying overseas. For instance, 71% of Gamuda’s order book is now derived from overseas, largely from Australia.
WCT, which has a long history in the Middle East, is reviving its exposure to the region by focusing on projects in Saudi Arabia and Qatar. Suncon is also bidding for a 55% stake in a US$2.4bn (c.RM11bn) Vietnam power plant project, which would be worth c.RM6bn.
While the market generally places a discount on such projects, CGSCIMB thinks it is Hobson’s choice and investors need to be selective and focus on contractors that have a track record overseas.
There also appears to be a shift of contractors to data centres and industrial building projects to fill the void left by the slowing residential property market.
Contractors’ balance sheets are stronger now Balance sheets of the larger contractors appear stronger now compared to the past two years.
Gamuda’s sale of its toll concessions has resulted in a net gearing position of 7% as of end-2QFY7/23. This is not withstanding the annual cashflow of c.RM800m that Gamuda expects to receive annually over the next 5 years from its local property townships.
Even prior to the sale of IJM Plantations, IJM has been emphasising that it would be bidding for PFI/investment-related projects from the government. This is quite similar to its West Coast Expressway (WCE) project, where it is the main contractor and it also received government loans. IJM’s net gearing has dropped to 24% as at 31 Dec 2023 (vs. 36-40% in FY21-20 prior to the sale of its plantation business).
“This is important given the high federal government debt-to-GDP ratio of 60.4% in CY22 (80.9% including contingent liabilities). Moreover, we believe that future contracts, such as the HSR, would have to be private sector-led, while we are uncertain whether MRT 3 would require contractor financing for the first two years,” the firm added.