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Rail awards Sector Update The Project Delivery Partner (PDP) contract for the HSR Malaysian infrastructure works was split between the YTL Corp-TH Properties and MRCB-Gamuda consortia. We believe the Gamuda-George Kent- Construction MMC Corp (GGM) consortium could also win part of the MRT3 project. We remain Overweight the Construction sector. We met up with Malaysia Rail Link (MRL) and gather that the Malaysian subcontracts for the ECRL project is expected to be rolled out in Overweight (maintain) 2Q18. Gamuda, MRCB and HSS are our top sector BUYs.
Gamuda-George Kent-MMC is likely winner of MRT3 According to The Edge, the GGM consortium and China Communications Construction Co. (CCCC) have been shortlisted for the Klang Valley Mass Absolute Performance (%)
Rapid Transit Line 3 (MRT3) turnkey with financing contract and could 1M 3M 12M share the civil works worth about RM45bn. We believe both consortiums AQRS 6.6 (15.7) 39.3 have the technical capabilities to undertake the project. But awarding the Gamuda 4.0 0.6 - HSS Eng 2.8 (0.9) 66.8 contract to a local player such as GGM will ensure a higher economic IJM Corp 10.2 (6.0) (18.0) impact with more local sourcing of materials and subcontract services. MRCB 2.9 (15.3) (30.0) Suncon (7.6) (19.5) (15.3) PDP for HSR Malaysian infrastructure announced WCT 7.5 (12.2) 25.0 Pintaras (10.9) (29.1) (38.3) MRCB-Gamuda (north section) and YTL-TH (south section) received WZ Satu (21.9) (36.2) (50.8) Letters of Intent (LOI) from MyHSR Corp for the Kuala Lumpur-Singapore High Speed Rail (HSR) Malaysian infrastructure PDP contract estimated to be worth RM30-35bn. This will kick-start the implementation of the project once the PDP terms are finalised in 2Q18. Potential engineering Relative Performance to KLCI (%) – consultant and contractor beneficiaries are HSS Eng, IJM Corp, Mudajaya, Gamuda, HSS, Suncon Suncon, WCT, Ahmad Zaki, Gadang, TRC Synergy and TSR Capital. GAMUDA HSS ENGINEERING WCT 500.00 Likely post-election rally 450.00 400.00 th The 14 general election (GE14) will be held on 9 May 2018. We believe 350.00 the construction stocks will rally post-election assuming there is no change 300.00 250.00 in government. GE14 uncertainties led to the pre-election correction in 200.00 construction stock prices. Construction stocks rallied post-election in 4 out 150.00 100.00 of 5 past GEs but declined in 2008 due to Global Financial Crisis (GFC) 50.00
concerns and Barisan Nasional losing its 2/3 majority in Parliament.
Jul17
Apr17 Oct 17
Jan 17 Jan 17 Jun 18 Jan
Mar 17 Mar 18 Mar
Feb 17 Feb 18
Dec 16 Dec 17 Nov 17 Dec
Aug17 Sep17 May17 Source: Affin Hwang, Bloomberg Maintain Overweight We believe potential news flow on contract awards for the MRT3, East Coast Rail Link (ECRL) and Pan Borneo Highway (PBH) Sabah projects will support the outperformance of the Construction sector in 2018 and we maintain our Overweight call. Our top BUYs are Gamuda (large cap), Loong Chee Wei, CFA MRCB (mid cap) and HSS (small cap). Gamuda is also selected as one of (603) 2146 7548 Daiwa Global Strategist Paul Kitney’s top picks. [email protected]
Construction peer comparison
Source: Bloomberg, Affin Hwang forecasts Note: Pricing as of close on 11 April 2018 Affin Hwang Investment Bank Bhd (14389-U)
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Key focus charts Fig 1: Construction order book at end-1Q18 Fig 2: Order book/revenue at end-1Q18
Source: Company, Affin Hwang estimates Source: Company, Affin Hwang estimates
Fig 3: Annual contract awards by type of projects Fig 4: Infrastructure works to be awarded in 2018 onwards Cost Infrastructure Social Amenities Residential Non-residential Project (RMbn) (RM bn) 250 KL-Singapore High Speed Rail Link (HSR) 60 East Coast Rail Line (ECRL) 55 200 Klang Valley MRT Line 3 (Circle Line) 45 Pan Borneo Highway Sabah (PBH) 13 150 Gemas-Johor Bahru Double-Tracking Rail 9
100 LRT Line 3 (Bandar Utama-Shah Alam-Klang) 2 Kuching LRT (3 lines) 11 50 West Coast Expressway 1 Total 195 0 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Source: CIDB Source: Affin Hwang estimates, various media sources
Fig 5: Aggregate construction core net profit and yoy change Fig 6: KL Construction Index 12-month forward PER
(x) 18 Latest PE. 13.2x 17 16 +1SD PE, 15.4 15 Mean PE, 13.7 14 13 12 11 -1SD PE, 12.0 10 9
8
Jul-15 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-16 Jul-17
Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Mar-17 Mar-18
Nov-12 Nov-09 Nov-10 Nov-11 Nov-13 Nov-14 Nov-15 Nov-16 Nov-17
Source: Affin Hwang estimates Source: Bloomberg
Affin Hwang Investment Bank Bhd (14389-U)
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GGM is likely winner of MRT3 GGM’s financing proposal is more attractive The tender for MRT3 closed in February 2018. We gather that GGM and CCCC have been shortlisted for the MRT3 turnkey contract with financing package. The Edge reported that CIMB Investment Bank and DanaInfra will provide financing at a 4.7% interest rate to support the GGM consortium’s bid while Chinese banks will offer US$ loans at a 5% interest rate to support CCCC’s bid.
Higher economic impact if MRT3 contract is awarded to locals GGM’s financing proposal with a lower interest rate and Ringgit- denominated bond issuance (no foreign-exchange risk) is more attractive, in our opinion. In addition, awarding the contract to a local player such as GGM will ensure a higher economic multiplier impact with more local sourcing of materials and subcontract services. We believe GGM will be awarded the project but it is uncertain whether it will need to share the project with CCCC, due to behind-the-scene lobbying. We gather that the project was supposed to be awarded this month but this could be delayed to after the election since the Prime Minister chairs the committee for MRT contract awards and he will likely be busy with election preparations.
Fig 1: Klang Valley Mass Rapid Transit Line 1-3
Source: Gamuda
Affin Hwang Investment Bank Bhd (14389-U)
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Potential boost to Gamuda’s order book Gamuda and MMC Corp each hold a 45% stake in the consortium while George Kent holds the remaining 10% stake. Gamuda’s share of the MRT3 contract could be about RM10-20bn assuming the consortium wins 50-100% of the estimated project value of RM45bn. The LOI for the HSR project could lead to a PDP contract worth another RM7.5-10.5bn. This would lift its current order book of RM13.5bn (including the MRT2 PDP contract).
PDP for HSR Malaysian infrastructure annouced Letters of Intent for HSR PDP issued to MRCB-Gamuda and YTL-TH MyHSR has issued Letters of Intent (LOI) to both the MRCB-Gamuda and YTL-TH consortia and the terms of agreement are to be mutually agreed upon by both parties within 3 weeks of the date of the LOI, ie, 5 April 2018. The PDP fee and project value has not been determined. We gather that the design and planning for the HSR project could take a year, which means construction contract awards will likely kick off in 2H19. The PDP will only be reimbursed by MyHSR for expenses incurred prior to the starting of civil works. Hence, earnings contributions from the PDP contract will mostly be recognised in 2020-26.
Fig 2: Kuala Lumpur-Singapore High Speed Rail
Source: MyHSR Corp
Not total loss for IJM and Suncon after losing HSR PDP bid The IJM Corp-Suncon-Jalinan Rejang-Maltimur Resources joint venture submitted a bid for the HSR PDP contract but lost the tender. However, IJM and Suncon can still bid for civil and station work packages for the HSR project in the future. They will have a competitive advantage given their strong track record and intimate knowledge about the HSR project gathered during the tender process for the PDP contract.
Affin Hwang Investment Bank Bhd (14389-U)
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HSS could win detailed design contract for HSR We believe HSS will be in a strong position to win the detailed design contract for part of the HSR project given it has secured the reference design contract worth RM17.9m earlier. The company also has a good working relationship with Gamuda and YTL as it was the engineering consultant for the Ipoh-Padang Besar Double Tracking (undertaken by the MMC-Gamuda joint venture) and Express Rail Link (undertaken by YTL) previously.
Potential contractor beneficiaries We believe the contractors that are undertaking civil works for the MRT project are potential beneficiaries of the HSR project given the established relationship with Gamuda and strong track record in undertaking major civil works and depot/station building works. Contractors that were involved in the MRT project include IJM Corp, Mudajaya, Suncon, WCT, Ahmad Zaki, Gadang, TRC Synergy and TSR Capital.
Potential earnings upside for Gamuda There is potential upside to our FY19-20E earnings estimates for Gamuda if both the MRT3 and HSR contracts are secured. We have assumed that Gamuda will secure the MRT3 contract worth RM10bn (PBT margin of 16%) in our earnings forecasts but have not assumed any earnings contribution from the potential HSR PDP contract. Based on a share of project value worth RM7.5-10.5bn and a PDP fee at 6% of project value, we estimate that Gamuda’s EPS could be lifted by 2.6-3.6% in FY20E.
Likely post-election rally KLCON rallied post-GE in 4 out of 5 past GEs The 14th general election (GE14) will be held on 9 May 2018. We believe the construction stocks will rally post-election assuming there is no change in government. The Bursa Malaysia Construction Index (KLCON) rallied post-GE13 on expectations of major infrastructure projects such as the MRT will be implemented under the government’s Economic Transformation Programme. GE14 uncertainties led to the pre-election correction in construction stock prices in 1Q18. Construction stocks rallied post-election in 4 out of the 5 past GEs but declined in 2008 after Barisan Nasional lost its 2/3 majority in Parliament.
Affin Hwang Investment Bank Bhd (14389-U)
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Fig 3: FBM KLCI and KLCON performance during election periods
Source: Bloomberg, Election Commission of Malaysia
KLCI underperformed FBM KLCI in 2008 due to GFC The market and Bursa Malaysia Construction Index (KLCON) fell 9.5% and 15.8% respectively on the first day of trading after the surprise result in GE12 on 8 March 2008. The global market rout during that period also contributed to the KLCON decline in tandem with the Global Financial Crisis (GFC) concerns. Excluding the impact of GFC, we believe the sector would have also outperformed post-election in 2008, given the policy certainties with BN remaining in power as per the prior years’ outcome and expectation of the award of the RM12.5bn Ipoh-Padang Besar Double Tracking project to the MMC-Gamuda JV, which came to pass in July 2008.
Risk of KLCON underperformance if GE14 outcome is unfavourable There is a risk of underperformance of the construction stocks in the event of a change in government or a hung Parliament as they could fall more sharply than the FBM KLCI. We believe the two key reasons for this possibility are the high beta of the construction stocks during the past 2 elections and concerns on slower government infrastructure spending.
High beta for construction stocks increases price volatility According to Bloomberg data, the long-term average adjusted beta for KLCON is 1.11, indicating that the index is more volatile than the FBM KLCI in general. We calculated the adjusted beta for KLCON for the 6- month period sandwiching the election dates, ie, 3 months before and after the election, for the past 5 GEs. We find that the KLCON adjusted beta was lower or close to the long-term average in GE9-11 but was higher than average in GE12-13.
Affin Hwang Investment Bank Bhd (14389-U)
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Fig 4: KLCON adjusted beta during election period Period Adj beta 25/1/1995 - 25/7/1995 (GE9 date 25/4/1995) 1.09 29/8/1999 - 29/2/2000 (GE10 date 29/11/1999) 1.09 21/12/2003 - 21/6/2004 (GE11 date 21/3/2004) 0.93 8/12/2007 - 8/6/2008 (GE12 date 8/3/2008) 1.24 5/12/2012 - 5/6/2013 (GE13 date 5/3/2013) 1.28 Average 1992-2018 1.11 Source: Bloomberg, Election Commission of Malaysia
Contractors’ higher dependence on government projects We believe this is due to the surge in infrastructure spending since 2013 and dependence of construction companies on government projects. Infrastructure contract awards comprised 60% of total contract awards in 2016 compared to the average of 33% in the 2006-16 period. The weak property market in recent years has also led to the contraction in property- related construction projects, hence heightening the risk faced by the construction companies to changes in government policy.
Fig 5: Annual infrastructure contract awards as a percentage of total
Source: Construction Industry Development Board
Key risk is change in government Public infrastructure projects have been the key driver for most listed construction companies’ order book expansions in recent years. There are concerns of slower government infrastructure spending if the opposition coalition Pakatan Harapan (PH) takes over the government. PH has relatively limited experience in running the federal government other than the political leaders that left the ruling coalition Barisan Nasional (BN) parties to join PH. PH’s GE14 manifesto also mentioned that large-scale projects awarded to foreign countries such as the ECRL will be reviewed, which could cause delays in the implementation of these projects.
Affin Hwang Investment Bank Bhd (14389-U)
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Fig 6: Annual infrastructure contract awards and yoy change
Source: Construction Industry Development Board
ECRL subcontracts to Malaysian contractors expected soon We met with MRL, which is the government’s special-purpose vehicle to finance and own the RM55bn ECRL (RM46bn in Phase 1 and RM9bn for Phase 2). We gather that CCCC is evaluating the Malaysian contractors to award subcontracts to undertake part of the infrastructure works for the ECRL. MRL has provided a list of 274 contractors to CCCC to choose from for subcontract awards. CCCC is required to award at least 30% of project value to local players, ie, about RM16.5bn.
The civil work subcontract packages could be awarded in 2Q18-3Q18. The ground-breaking ceremony in Kelantan is scheduled for today and another ceremony in Terengganu will be held soon. The base camps for the workers are nearly complete along the alignment. The good progress made will likely lead to the early completion for the project ahead of the June 2024 deadline based on the initial schedule, possibly by end-2023. MRL is looking to issue an initial Sukuk bond to finance 15% of the cost. The balance, 85%, of the total project cost will be financed by the Export- Import Bank of China at an interest rate of 3.25% p.a.
Gamuda is likely out of the picture for ECRL We gather that Gamuda was negotiating for the entire portion of works to be awarded to local players. But CCCC and Gamuda could not agree on the pricing for the contract. Hence, CCCC will likely split the subcontracts into smaller packages to be awarded to the politically-linked contractors in each state. We believe potential beneficiaries are AQRS, IJM, WCT, WZ Satu and Advancecon.
Affin Hwang Investment Bank Bhd (14389-U)
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Fig 7: East Coast Rail Link
Source: Malaysia Rail Link
Maintain Overweight New contract awards to remain strong Assuming there is no change in government, news flow of contract awards will remain strong due to RM195bn worth of large-scale infrastructure projects to be implemented. We believe the contract awards will remain strong post-election due to the government’s commitment to roll out the projects. This will drive construction order book expansion for the contractors and improve earnings visibility.
Fig 8: Planned large-scale infrastructure projects to be implemented in 2018-19 Cost Project (RMbn) Gamuda-MRCB, Suncon-IJM-Jalinan-Maltimur, YTL-SIPP, HSS, KL-Singapore High Speed Rail Link (HSR) 60 George Kent East Coast Rail Line (ECRL) 55 AQRS, Fajarbaru, Gamuda, IJM, Advancecon, HSS Klang Valley MRT Line 3 (Circle Line) 45 Gamuda-George Kent-MMC, HSS Pan Borneo Highway Sabah (PBH) 13 WCT, Suria Capital-AQRS, Gamuda Gemas-Johor Bahru Double-Tracking Rail 9 YTL-SIPP LRT Line 3 (Bandar Utama-Shah Alam-Klang) 2 IJM, Gamuda, Gadang, Fajarbaru Kuching LRT (3 lines) 11 CMS, Naim, Gamuda, IJM, WCT, Suncon West Coast Expressway 1 Mitrajaya, WCT, Advancecon Total 195 Source: Affin Hwang, various media sources Affin Hwang Investment Bank Bhd (14389-U)
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Strong construction sector earnings growth We expect the Construction sector core net profit for our universe of stocks to grow 15% yoy in FY18E and 23% yoy in FY19E. Earnings growth is expected to moderate from 30% yoy in FY17 from a low base. Our bullish earnings forecasts are supported by the acceleration in core net profit growth to 76% yoy in 4Q17 from 13% yoy in 3Q17.
Fig 9: Construction sector core net profit and yoy change
Source: Affin Hwang
Top BUYs are Gamuda, MRCB and HSS We remain Overweight the construction sector as we expect contract awards to remain strong post-election, and sustained strong sector earnings growth driven by record-high order books and good new contract procurement prospects. Our top BUYs are Gamuda (large cap), MRCB (mid cap) and HSS (small cap). AQRS is another small-cap pick for a potential subcontract award for the ECRL project. Gamuda is also selected by Daiwa’s Global Strategist Paul Kitney as one of his Animal Spirits Top Picks in his report Animal Spirits (Pan Asia Strategy) – Align with the right paradigm, bottom fishers! dated 10 April 2018.
Fig 10: Construction peer comparison Stock Bbg Rating Sh Pr TP Mkt cap Core PER (x) Core EPS gr (%) P/BV (x) ROE (%) DY (%) (RM) (RM) (RMbn) CY18E CY19E CY18E CY19E CY18E CY18E CY18E IJM Corp IJM MK BUY 2.82 3.65 10.2 18.8 15.5 15.2 21.1 0.8 4.6 2.9 Gamuda GAM MK BUY 5.15 5.85 12.6 16.7 14.4 15.8 16.5 1.8 11.9 2.3 MRCB MRC MK BUY 1.05 1.28 4.6 21.2 13.7 8.1 55.1 0.9 9.7 1.9 WCT Hldg WCTHG MK BUY 1.22 2.36 1.7 9.6 8.3 50.6 15.7 0.5 6.0 1.9 Sunw ay Construction SCGB MK HOLD 2.30 2.45 3.0 16.9 15.1 29.7 12.1 4.7 27.5 3.0 Gabungan AQRS AQRS MK BUY 1.77 2.25 0.8 15.9 10.6 55.4 50.3 2.1 17.2 1.7 WZ Satu WENG MK SELL 0.63 0.76 0.2 21.5 13.7 (21.9) 57.0 0.6 3.6 5.1 Pintaras PINT MK HOLD 3.05 3.95 0.5 15.1 10.8 11.7 40.3 1.5 10.0 6.6 HSS Engineering HSS MK BUY 1.47 1.70 0.5 17.0 14.3 86.8 18.5 2.4 11.5 1.6 Weighted average 15.7 12.8 25.8 23.1 1.7 8.1 3.1 Source: Bloomberg, Affin Hwang forecasts Note: Pricing as of close on 11 April 2018
Affin Hwang Investment Bank Bhd (14389-U)
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Equity Rating Structure and Definitions
BUY Total return is expected to exceed +10% over a 12-month period
HOLD Total return is expected to be between -5% and +10% over a 12-month period
SELL Total return is expected to be below -5% over a 12-month period
NOT RATED Affin Hwang Investment Bank Berhad does not provide research coverage or rating for this company. Report is intended as information only and not as a recommendation
The total expected return is defined as the percentage upside/downside to our target price plus the net dividend yield over the next 12 months.
OVERWEIGHT Industry, as defined by the analyst’s coverage universe, is expected to outperform the KLCI benchmark over the next 12 months
NEUTRAL Industry, as defined by the analyst’s coverage universe, is expected to perform inline with the KLCI benchmark over the next 12 months
UNDERWEIGHT Industry, as defined by the analyst’s coverage universe is expected to under-perform the KLCI benchmark over the next 12 months
This report is intended for information purposes only and has been prepared by Affin Hwang Investment Bank Berhad (14389-U) (“the Company”) based on sources believed to be reliable. However, such sources have not been independently verified by the Company, and as such the Company does not give any guarantee, representation or warranty (express or implied) as to the adequacy, accuracy, reliability or completeness of the information and/or opinion provided or rendered in this report. Facts, information, views and/or opinion presented in this report have not been reviewed by, may not reflect information known to, and may present a differing view expressed by other business units within the Company, including investment banking personnel. Reports issued by the Company, are prepared in accordance with the Company’s policies for managing conflicts of interest arising as a result of publication and distribution of investment research reports. Under no circumstances shall the Company, its associates and/or any person related to it be liable in any manner whatsoever for any consequences (including but are not limited to any direct, indirect or consequential losses, loss of profit and damages) arising from the use of or reliance on the information and/or opinion provided or rendered in this report. Any opinions or estimates in this report are that of the Company, as of this date and subject to change without prior notice. Under no circumstances shall this report be construed as an offer to sell or a solicitation of an offer to buy any securities. The Company and/or any of its directors and/or employees may have an interest in the securities mentioned therein. The Company may also make investment decisions or take proprietary positions that are inconsistent with the recommendations or views in this report.
Comments and recommendations stated here rely on the individual opinions of the ones providing these comments and recommendations. These opinions may not fit to your financial status, risk and return preferences and hence an independent evaluation is essential. Investors are advised to independently evaluate particular investments and strategies and to seek independent financial, legal and other advice on the information and/or opinion contained in this report before investing or participating in any of the securities or investment strategies or transactions discussed in this report.
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