Construction - The party’s over




Post GE14, the new PH government has embarked on a review of all mega projects. The HSR and MRT3 have been scrapped while terms of the ECRL are being renegotiated. We believe ongoing jobs such as MRT2, LRT3 and Pan Borneo Sarawak will proceed as planned. The review of mega projects is negative for contractors as it would lead to project rollout delays or cancellations. We reckon that new contract awards for 2018 will come in at RM10-15bn, significantly lower than 2017 (RM29bn) and 2016 (RM56bn). We cut our sector rating from Overweight to NEUTRAL. In terms of stock call changes, our Buys on Gamuda, GKent, WCT and MRCB are all reduced to HOLD.

Project reviews by the new government. Post GE14, the new Pakatan Harapan (PH) government has embarked on a review of all mega projects, as promised in its manifesto. This is to ascertain if the proposed projects by the previous government are on terms that are fair and if they actually make sense to be implemented. We read the flagging of Malaysia’s RM1trn government debt by PH as a sign that the new administration is taking a cautious stance on the nation’s fiscal position. Coupled with the recent GST “zerorisation”, we reckon that PH’s propensity to spend on mega infra projects would be curtailed, at least in the near term.

HSR and MRT3 off the cards. PM Tun Mahathir officially announced that the HSR (RM60-70bn) and MRT3 (RM40bn) are scrapped as the PH attempts to tackle the high level of government debt. Both projects have yet to commence any physical work. Earlier in April, the MRCB-Gamuda JV was appointed PDP for the HSR northern stretch and YTL-THP JV for the southern section. Also, GKent (in a consortium with European partners) were bidding for the HSR AssetsCo role (i.e. systems and rolling stock). For MRT3, the finalists for the turnkey contractor role were MMC-Gamuda-GKent JV and China state owned CCCC.

ECRL renegotiated. Terms of the ECRL (RM60bn) which was awarded to CCCC and funded by a RM55bn loan from Exim Bank, will be renegotiated. As of end March, progress on the ECRL stood at 13%. An article on The Edge cited several “unusual arrangements” on the contract which include (i) payments that were not tied to work progress and (ii) alleged inflated project cost from RM30bn to RM60bn.

Ongoing projects likely to continue. We reckon that mega projects such as the MRT2 (RM32bn), LRT3 (RM12bn) and Pan Borneo Sarawak (PBH) (RM16bn) will proceed as planned as work is already ongoing. Progress of MRT2 has hit 15-20% (Jan), Pan Borneo Sarawak at 15% (Mar) and LRT3 at 10% (May).

Job flows to slow. From the perspective of contractors, the reviews are negative for the sector as it would inevitably lead to project rollout delays or outright cancellation. As it is, domestic contract awards to listed contractors from Jan-May of RM7.5bn are already down 23% YoY. We reckon that contract awards for 2018 will likely come in at RM10-15bn, significantly lower than the RM29bn and RM56bn in 2017 and 2016. However, following robust job flows in the past 2 years, we note that most contractors under our coverage are still sitting on near record high orderbook levels with an average cover ratio of 4.9x (3.5x if high outliers removed).



Downgrade to NEUTRAL. With the slowdown in contract flows being the new reality, we turn cautious on the sector and downgrade our rating from Overweight to NEUTRAL. Nonetheless, the saving grace comes from high orderbook levels which should help sustain construction earnings amid lull job flows. The KLCON plunged 27% since GE14 vs the KLCI’s 5% decline over the similar period. Despite the sharp fall, we see little prospects for a near term rebound as catalysts are lacking.
Stock Call Changes

Gamuda – Downgrade to HOLD

We downgrade Gamuda from Buy to Hold following the cancellation of mega rail projects such as MRT3 and HSR that it was previously eyeing on. While these contracts were never imputed directly into our forecast, we reckon these cancellations would make it hard to justify Gamuda’s pre-GE14 valuations. Earnings over the next 3 years (FY18-20) will nonetheless, still be supported by its ongoing MRT2 works. However, earnings sustainability beyond this would be in question. We lower construction P/E target from 18x to 15x and also incorporate a 30% discount to SOP. This reduces our TP from RM5.66 to RM3.58.

George Kent – Downgrade to HOLD

We downgrade GKent from Buy to Hold following the cancellation of mega rail projects such as MRT3 and HSR which it was previously targeting for. While these contracts were never imputed directly into our forecast, we reckon these cancellations would make it hard to justify GKent’s pre-GE14 valuations. Earnings over the next 3 years (FY19-21) would be supported be the LRT3 PDP role. Nonetheless, earnings sustainability beyond this is in question. Our revised SOP valuation for GKent is based on a bear case scenario using (i) NPV (WACC: 12%) for its engineering division with nil orderbook replenishment, (ii) 10x P/E for metering assuming no YoY growth and (iii) 30% discount to its net cash per share. Under this bear case scenario, our SOP based TP is reduced from RM3.25 to RM1.50.

WCT – Downgrade to HOLD

We downgrade WCT from Buy to HOLD given the macro slowdown in job flows arising from the review of mega projects. Our annual job win target has already been reduced from RM1bn to RM500m during the 1QFY18 results review. However, we take this opportunity to widen WCT’s SOP discount from 30% to 50%. Our TP is cut from 1.09 to RM0.78.

MRCB – Downgrade to HOLD

We downgrade MRCB from Buy to HOLD given its recent share price rebound which narrows the upside potential. Our SOP based TP is unchanged at RM0.68.

Source: Hong Leong Investment Bank Research - 5 Jun 2018