THAILAND Sector Note 6 MARCH 2013 Sector Outlook c Sector Weighting Neutral Thailand Construction Sector Selective BUYs Sector Valuation Current Target Norm EPS grw ⎯ Norm PE ⎯ ⎯ P/BV ⎯ ⎯ Div yield ⎯ BBG Price Price 2013F 2014F 2013F 2014F 2013F 2014F 2013F 2014F Company Code Rec. (Bt) (Bt) (%) (%) (x) (x) (x) (x) (%) (%) Ch. Karnchang CK TB SELL 27.25 20.00 300.7 166.4 193.8 72.7 3.6 3.7 1.7 0.6 Sino-Thai Eng. STEC TB BUY 35.00 42.00 15.0 20.2 31.0 25.8 5.6 4.9 1.3 1.6 Toyo-Thai Corp TTCL TB BUY 37.75 51.00 58.2 30.3 20.9 16.1 7.2 5.8 2.4 3.1 Source: Thanachart estimates Note: Prices as of close on 4 March 2013; TP for STEC is before the stock dividend We are optimistic on the government’s Bt2tr infrastructure bill. Contractors’ top lines should benefit but we don’t expect all to avoid a margin squeeze given rising building material costs. We see STEC and TTCL as the best cost managers with net cash positions but TTCL is our top pick as we view its valuation as more enticing. Neutral sector weighting We maintain our Neutral stance on the Thai contractor sector. Despite SAKSID PHADTHANANARAK the government’s massive infrastructure bill, we expect contractors to 662 – 617 4900 suffer from: 1) rising building material prices as the government is [email protected] imposing anti-dumping duties on steel imports from China; and 2) the minimum wage hike and a labor shortage. Moreover, the sector has Infrastructure Investment Plan already outperformed the SET by 155% since early 2012 with PE (US$ m) multiples now at very high levels of 42x for 2013F and 31x for 2014F. 12,000 10,000 8,000 Optimistic outlook for construction 6,000 4,000 The government is now moving ahead with a Bt2tr (US$66bn) 2,000 0 infrastructure bill. The bill, which we see as likely to pass parliament by mid-2013, would allow the government to raise funds in addition to the Thanachart Securities annual budget over the next seven years. Some 97% of the budget is Source: OTP, Report on Investment Plan for targeted at rail and road transport investments. Potential projects in the Transport Sector (Year 2013-2020), pipeline in 2012-16 include Bt481bn for high-speed trains, Bt298bn for double-track railways, Bt321bn for mass transit systems, and Bt369bn for Contractor PEG Is Not Cheap roads, highways and motorways. This investment plan is on top of the (x) 2013F 2014F Bt350bn flood prevention scheme for which the government has just 3.0 2.5 announced six qualified contractors to bid for projects. 2.0 1.5 1.0 Rising construction costs 0.5 0.0 While we are less concerned over top-line growth, we still see contractors as exposed to a margin squeeze risk due to a rising proportion of low- Thanachart Securities margin government work. Moreover, we see construction costs increasing due to the minimum wage hike, labor shortage and sustained Source: Thanachart estimates high energy costs. Moreover, we expect the government to levy anti- dumping duties on steel sheet imports from China this year, which we estimate will push domestic steel prices up by 10-15%. Raw material and ROE Comparison labor expenses account for around 65% of contractors’ total costs. (%) CK STEC TTCL 50 40 Our top pick is TTCL 30 20 As government projects have very low margins at 5-8%, marginal cost 10 0 overruns could turn contractors’ earnings into losses. We therefore prefer (10) contractors with effective cost controls, net cash positions and good- quality backlogs. We believe these characteristics match STEC, a pure domestic play which we believe has the strongest financial status and Source: Company data best cost management. TTCL is the best play for the Asean Economic Community (AEC) growth market in our view as it focuses on high-margin engineering work without risky civil work. We believe TTCL’s investments in power plant projects would also allow it to secure future growth. However, our top pick is TTCL as we see its valuation as more enticing. Please see the important notice on the back page CONTENTS SAKSID PHADTHANANARAK Contents Page Neutral on construction sector …..……………………………………………………………………………….……...…………….. 2 Why does the sector trade at very high PE? …..…………………………………………………….…………..…..…………….… 3 Optimistic on future construction outlook …..………….………………………………………….……………..………………..… 4 Upcoming new infrastructure cycle …………………………………………..……………………………………..……………. 4 Where does the funding come from? ………………………………………..……………………………………..……………. 5 No need for all, only some is enough …………………………………………………………………………………………..… 7 The bigger the pie, the larger the slices for all ………………………………….………………………………………………. 9 Project bids lining up in 2013-14 ……………………………………………………………..……………………….…………. 10 Rising construction costs …..…………………………………………………….………………………………..………………..… 11 Further minimum wage hike by 22% in 2013 ……………………………………………..…………………………………… 11 Rising building material prices ………………………………………………………………………………………..…………. 12 Our top pick is TTCL…………………………...…..………………………………….……………………………..………………..… 14 STEC: Best local infrastructure play …………………………………………………………...…………..…………………… 14 TTCL: Top AEC growth play …………………………………………………………………...……………………..…………. 16 CK: Turnaround seems in the price …………………………………………………………………………………….………. 17 Sector Valuation Comparison …..………………………………………………………………………………………..…………… 19 Appendix …………………………………..…………………………………………………………….……………………………….. 20 Company Notes…..……………………………………………………………………………………..……………………………...……. Ch. Karnchang (CK TB) — Turnaround seems in the price ...………………………….…………………………………… 21 Sino-Thai Eng & Constr (STEC TB) — Best local infrastructure play ………...………………………….………………… 28 Toyo-Thai Corp (TTCL TB) — Top AEC growth play………...………………………….…………………….……………… 35 THANACHART SECURITIES | DAIWA CAPITAL MARKETS SECTOR NOTE SAKSID PHADTHANANARAK Neutral on construction sector We have a Neutral The Thai contractor sector has performed very well since early 2012, surging by 192% and weighting on the outperforming the Stock Exchange of Thailand (SET) Index by 155%. We believe that construction sector … investor optimism toward the sector has incorporated expectations that the government's massive Bt2tr (US$66bn) infrastructure bill will be passed by parliament. We share the view that if the new law passes it would help kick-start a new infrastructure cycle in Thailand. However, we have a Neutral weighting on the sector for four key reasons: … as we believe It’s too First, while share price performances to a certain degree have in our opinion reflected the optimistic to assume the optimism above, we see the full implementation of the seven-year investment plan as infrastructure bill is fully having a lot of risks attached. Therefore, we believe it would be too sanguine to assume the implemented … bill is fully implemented. …we don’t expect the Second, assuming the bill passes the House in mid-2013 and there are some project bids investments to actually during 2H13, we don’t see serious money or revenue coming this year. We base this come in this year… assessment on construction normally not starting in a big way until six to nine months after bidding results are released. …and we don’t see every Third, we are confident about contractors’ strong top-line growth but we don’t believe all of contractor enjoying them will enjoy higher profits as construction costs are also on a rising trend due to the higher profits … minimum wage hike, a labor shortage and higher building material prices. … the sector trades at a Fourth, even though the sector has tended to trade in the past at high PE, it is already near very high PE the peak range during the great bubble period in the mid-1990s, when Thailand was enjoying the peak of its infrastructure cycle. The sector's current PE multiples are now at very high levels of 42x for 2013F and 31x for 2014F versus its historical range of 15-25x. Ex 1: Contractor Sector’s PE Band Chart Ex 2: CK’s PE Band Chart (Bt bn) (Bt/share) 300x 200 65x 120 250x 150 55x 100 45x 200x 100 35x 80 25x 50 150x 15x 60 100x 0 40 50x (50) 20 (100) 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013F 2014F 2015F 2013F 2014F 2015F Sources: Company data, Thanachart estimates Sources: Company data, Thanachart estimates THANACHART SECURITIES | DAIWA CAPITAL MARKETS 2 SECTOR NOTE SAKSID PHADTHANANARAK Ex 3: STEC’s PE Band Chart Ex 4: TTCL’s PE Band Chart (Bt/share) (Bt/share) 70 140 39x 60 120 42x 32x 50 100 35x 25x 40 80 28x 18x 30 60 11x 21x 20 40 14x 10 4x 20 7x 0 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2010 2011 2012 2013F 2014F 2015F 2013F 2014F 2015F Sources: Company data, Thanachart estimates Sources: Company data, Thanachart estimates Why does the sector trade at very high PE? The contractor sector has Being a contractor is a risky business, in our view. We see it as synonymous with low profit tended to trade at high margins despite the high risk from often inconsistent work volumes, building material price PE multiples in the past volatility, labor shortages, disputes about projects, and late payments by project owners. because … These risks can also cause contractors’ earnings visibility to be opaque. Even so, the sector is still trading at very high PE multiples and we believe this is because: … 1) the construction First, the construction cycle is very lengthy, and this would especially be the case if cycle is lengthy … Thailand’s multi-year infrastructure investment cycle gets going. …2) contractors’ backlog Second, contractors’ top-line growth can be predicted based on their backlog values and value can guarantee their many Thai contractors have been reporting record-high backlog values. top-line growth However, given the risks mentioned above, we do not expect every contractor to be able to deliver top-line growth to their bottom lines. We therefore prefer contractors with effective Our top pick is TTCL cost controls, low gearing or net cash positions and good-quality backlogs.