16 March 2016 Roll out Sector Update The construction sector saw a core EPS contraction of 4.5% YoY in 2015 due to slow order book replenishment. We expect the acceleration in contract awards since 3Q15 and into 2016 to drive Construction earnings growth of 24.8% YoY in 2016. We look for the rollout of large-scale public transportation and highway projects worth over RM75bn in 2016 to spur an upward re-rating of the construction Overweight (maintain) sector. We remain Overweight the sector and our top BUYs are Gamuda, Sunway Construction (Suncon) and WCT. Strong earnings rebound expected in 2016 Most of the construction companies saw core EPS contractions in 2015 Absolute Performance (%) due to slow construction order book replenishment and weak property 1M 3M 12M sales. However, earnings for several construction companies such as Benalec -1.9 -9.0 -38.8 Eversendai, IJM Corp, MRCB and WCT were boosted by exceptional Eversendai +2.2 -10.3 -14.1 gains. The award of contracts has accelerated since 3Q15 with major Gamuda +8.5 +7.7 -8.3 infrastructure contracts awarded for the Refinery and Petrochemical GAQRS +2.4 +1.2 -38.2 Integrated Development (RAPID), West Coast Expressway (WCE) and IJM Corp +1.5 +2.4 -4.3 MRCB +4.4 -4.0 -7.0 Pan-Borneo Highway (PBH). We expect order book expansion for most of SUNCON +9.2 +9.2 +7.0 the contractors under our coverage to spur strong core EPS growth of WCT Hldgs +0.6 +7.9 +7.0 24.8% YoY in 2016 compared to a contraction of 4.5% YoY in 2015. Major infrastructure projects to roll out Relative Performance (%) Major rail projects such as the Klang Valley Mass Rapid Transit Line 2 SCGB Gamuda WCT (MRT2) and Light Railway Transit Line 3 (LRT3), Kuala Lumpur-Singapore 140.00 130.00 High-Speed Rail (HSR) and Southern Double-Tracking (SDT) are in the 120.00 pipeline. Implementation of the MRT2 project is imminent, and major 110.00 contract awards are expected to start in March/April. Besides the PBH and 100.00 90.00 WCE, two major highways in the pipeline for implementation this year are 80.00 Sungai Besi-Ulu Kelang Elevated Expressway (SUKE) and Damansara- 70.00 Jul-15 Jan-16 Jan-15 Jan-15 Jun-15 Oct-15 Apr-15 Feb-15 Sep-15 Feb-16 Dec-15 Dec-15 Aug-15 Nov-15 Mar-15 Shah Alam Highway (DASH). This should support the construction order May-15 Source: Affin, Bloomberg. When a report covers six or more book growth for contractors in 2016 and improve earnings visibility. subject companies please access important disclosures for Daiwa Capital Markets Hong Kong Limited at Domestic growth story http://www.daiwacm.com/hk/research_disclaimer.html or The shift in investor focus away from export-oriented companies to contact your investment representative or Daiwa Capital Markets Hong Kong Limited at Level 26, One Pacific Place, domestic plays given the strengthening of the Ringgit should generate 88 Queensway, Hong Kong. 8Hong Kong interest in construction stocks. We expect the award of major billion Ringgit contracts to accelerate this year to show progress in infrastructure development in a potential election year in 2017. The general election has to be held by March 2018. The acceleration in infrastructure spending should also support economic growth given the external headwinds. Maintain Overweight We are Overweight on the construction sector as we believe sector core EPS growth in 2016 will exceed the market average. Our top BUYs are Gamuda Loong Chee Wei CFA among the large-caps and Suncon and WCT among the mid-caps. We believe (603) 2146 7548 these are the companies with the best prospects to win major contracts this [email protected] year. The de-gearing efforts by WCT through the potential listing of its construction arm and REIT should unlock value, in our view. Stock Bbg Rating Sh Pr TP Mkt cap Co r e PER ( x) Core EPS gr (%) P/BV (x) ROE ( %) DY (%) (RM ) (RM ) (RMbn) CY16E CY17E CY16E CY17E CY16E CY16E CY16E IJM Cor p IJM MK BUY 3.39 3.76 12.1 19.0 15.6 18.2 22.3 1.0 5.8 3.1 Gamuda GA M MK BUY 4.70 5.59 11.3 19.3 17.3 (7.3) 11.5 1.6 10.1 2.6 MRCB MRC MK BUY 1.15 1.46 2.1 29.3 22.6 200.7 29.8 0.9 2.8 2.2 WCT Hldgs WCTHG MK BUY 1.63 1.90 2.0 15.8 10.7 87.8 47.9 0.7 5.4 3.7 Sunw ay Construction SCGB MK BUY 1.53 1.74 2.0 14.0 11.5 3.9 22.0 3.8 29.1 3.6 Eversendai EV SD MK BUY 0.71 0.84 0.5 8.4 7.3 25.0 15.1 0.6 6.2 5.6 Benalec BHB MK HOLD 0.51 0.56 0.4 8.2 6.9 104.9 19.3 0.7 8.6 5.0 Gabungan AQRS A QRS MK SELL 0.85 0.70 0.3 10.9 8.8 (402.8) 24.2 1.0 9.2 1.8 Malaysian w gt avg 17.0 14.1 24.8 20.2 1.1 6.9 2.7 Source: Affin estimates, Bloomberg, Note: Pricing as of close on 15 March 2016 Affin Hwang Investment Bank Bhd (14389-U) (Formerly known as HwangDBS Investment Bank Bhd) Page 1 of 13 16 March 2016 Construction contract awards likely bottomed in 4Q15 The lack of major infrastructure projects and the slowdown in property development activities contributed to the 43% YoY decline in total construction contract awards to RM96.1bn in 2015 from RM167.6bn in 2014. 4Q15 was the weakest quarter in terms of contract awards, ie, 52% QoQ and 74% YoY decline to RM12bn in 4Q15. Fig 1: Annual contract awards by government and private sector Source: Construction Industry Development Board Fig 2: Quarterly contract awards by government and private sector Source: Construction Industry Development Board Record order books for some construction companies Despite the fall in construction contract awards, we believe the small unlisted contractors were affected the most. Some of the large listed construction companies under our coverage, ie, IJM Corp, Malaysian Resources Corp (MRCB) and WCT, had record order books at end-2015. This was achieved by clinching contracts for large-scale projects such as WCE, RAPID, Kwasa Damansara, Cyberjaya Commercial Centre (CCC) and Tun Razak Exchange (TRX). Note that most of the projects that kicked off last year excluding the Affin Hwang Investment Bank Bhd (14389-U) (Formerly known as HwangDBS Investment Bank Bhd) Page 2 of 13 16 March 2016 WCE are related to property development and building works, which generally are lower in value compared to infrastructure projects. Fig 3: Construction order book of companies under coverage Source: Company, Affin Hwang estimates Good earnings visibility IJM, MRCB and WCT have the best earnings visibility, as their outstanding order book is more than 2x their historical annual construction revenue. We believe the potential new contracts to be secured this year by Suncon, WCT and Gamuda (our top sector picks) will grow their order book and improve earnings visibility to narrow the gap with peers such as IJM and MRCB. Fig 4: Construction order book / Annual revenue ratio of selected companies Source: Company, Affin Hwang estimates Cut in government development expenditure The government has reduced development expenditure by RM5bn to RM45bn under the recalibrated Budget 2016 announced on 29 January 2016. The implementation of non-physical projects and projects that are still under study is to be rescheduled. Physical projects that will be prioritised include construction of affordable houses, hospitals, schools, Affin Hwang Investment Bank Bhd (14389-U) (Formerly known as HwangDBS Investment Bank Bhd) Page 3 of 13 16 March 2016 roads and public transport as well as security. The reduced development expenditure budget for 2016 is still 21% higher than the amount spent in 2015. Fig 5: Annual development expenditure under five-year Malaysia Plans Source: Ministry of Finance, Bank Negara Malaysia But we believe the impact is not substantial as large-scale infrastructure projects such as the MRT, LRT, PBH and HSR should proceed. Malaysian Vision Valley (Sime Darby-EPF), CCC (MRCB) and HSR are to be implemented on a public-private partnership basis and hence private investments should reduce the burden on the government’s finances. Meanwhile, RAPID should continue to be developed by Petronas due to committed investments to build the refinery and oil storage facilities. Funding from private sector The MRT, LRT and PBH are to be funded by government-guaranteed bonds raised by DanaInfra, the government’s special-purpose vehicle to finance infrastructure projects. Hence, it is not affected by the cut in development expenditure since DanaInfra’s government-guaranteed bonds are just a contingent liability, for which repayment and debt servicing will come from operating expenditure in the future. However, the government indicated that new projects in the planning stage could be deferred. Rise in investments from China Malaysia is benefiting from the rising investments in infrastructure and property development projects from China due the latter’s “One Belt, One Road” development strategy to improve connectivity and cooperation with European and Asian countries. Chinese state-owned enterprises (SOE) have proposed to acquire 1MDB power assets for RM9.83bn and invest up to RM7.41bn for a 60% stake in the Bandar Malaysia development. A consortium of Chinese railway construction companies was awarded the RM8bn SDT project a few months ago, which would mainly be funded by soft loans from the Chinese government.