HLIB Research

PP 9484/12/2012 (031413)

Construction (Overweight )

INDUSTRY INSIGHT 10 January 2017

2017 Outlook: Time for normalisation

Highlights  Flattish spending for 2017 but... Development expenditure Jeremy Goh, CFA
for 2017 has been set at RM46bn, flattish at +2% YoY. This pwgoh@hlib.hongleong.com.my
should help sustain nominal construction output given its (603) 2168 1138
strong correlation (73%) to development expenditure.
KLCON Index (294.69 pts)
 ...picking up later on. 11MP (2016-2020) has an allocation
Pts Pts
of RM260bn, 13% higher than 10MP. Subtracting the 300.00 1750
RM45bn allocation for 2016 and RM46bn for 2017 leaves a 295.00 1730
balance of RM169bn for 2018-2020. Assuming this is 1710
290.00
1690
spreaded equally over 3 years, spending momentum could 285.00 1670
pick up strongly in 2018 by +22% to RM56bn. 280.00 1650
275.00 1630
 Outperformance continues. Real construction growth has 270.00
1610
1590
outperformed overall GDP since 1Q12. Our economics team 265.00
KLCON (LHS) KLCI (RHS)
1570
expects the outperformance of construction to persist into 260.00 1550
2017 at 10% against an overall GDP growth of 4.5%. Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16

 A year of normalisation. 2016 witnessed a record showing Stock Rating Price Target
of contract flows at RM56bn which was up +158% YoY and Gamuda BUY 4.95 5.67
also surpassed the previous high of RM28bn in 2012. IJM BUY 3.35 3.92
Coming from a significantly higher base, it would only be WCT HOLD 1.83 1.99
rational to expect a downward normalisation in job flows for MRCB HOLD 1.38 1.37
2017 and expect this to come in at RM25bn. Edgenta BUY 3.27 3.85
SunCon BUY 1.69 1.93
 Rollouts for the year. Expected mega projects for 2017 Eversendai HOLD 0.615 0.57
include remaining packages of the MRT2 (RM5bn) in 1H, Kimlun BUY 2.15 2.66
LRT3 (RM9bn) awards to begin in 1Q and potentially the HSL BUY 1.65 2.00
Mitrajaya BUY 1.29 1.95
mammoth ECRL (RM55bn) towards end 2017 at earliest. GKent BUY 3.06 3.77
 Boost from Greater KL. Several catalytic developments Pesona BUY 0.615 0.81
have emerged in Greater KL which include TRX, Warisan
Merdeka, BBCC, Bandar M’sia, Kwasa D’sara and CCC.
Collectively, these developments have GDV of at least
RM275bn and could potentially generate RM138bn worth of
works for contractors to undertake.

Risks  The key risk is a softening domestic property market which

may see slower job flows from private sector developers.

Rating / OVERWEIGHT
Valuation  While we expect a downward normalisation in job flows for
2017, we retain our OVERWEIGHT rating on the sector. The
strong contract flows registered last year will translate into
earnings growth for 2017.

Top Picks  Gamuda (BUY, TP: RM5.67) is our top pick amongst the
large cap contractors as it is set to see a revival of earnings
growth in FY17 and potentially a new high in FY18.
Catalysts include the MRT3, PTMP and sale of SPLASH.
 For the small caps, we like GKent (BUY, TP: RM3.77) as a
key rail play (LRT ext, LRT3 and MRT2). It has 3-year
earnings CAGR of 28%, above industry ROE and net cash.
 We also like Pesona (BUY, TP: RM0.81) as it offers
exposure to a pure construction play with incoming recurring
income stream. 3-year earnings CAGR is projected at a
robust 61% on back of increasing ROE and net cash
position.

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Highlights
Favourable long term macro outlook

Higher allocation under 11MP. 2017 marks the 2nd year of the 11MP which spans
11MP allocation 13% higher
from 2016-2020. Arguably, this will be the most important Malaysia Plan as it ends in
than 10MP
2020, the target timeline for the country to achieve a “high income nation” status as
envisaged under its goal of Vision 2020. For the 11MP, an allocation of RM260bn has
been set, representing a 13% increase from the 10MP. We expect this to sustain
contract flows over the longer term.

Figure #1 Allocation under past Malaysia Plans (RM bn)

300
260
250 230 230

200
170

150

100
100

50

-
7MP 8MP 9MP 10MP 11MP

11MP and past MP blueprints

Flattish spending for 2017 but... As shown below, nominal construction output (i.e. Development expenditure for
ringgit value of construction work) is correlated to development expenditure at 73%.
2017 only marginally higher
For 2017, development expenditure is set at RM46bn (+2% YoY). While this may
by 2% YoY but…
appear relatively flat YoY, the sum is still the highest recorded over the past 5 years.

Figure #2 Nominal construction GDP and DE (RM bn)

60 60
Dev Exp (RHS)

50 Nominal Output (LHS) 50

46

40 40

30 30

20 20

10 10

- -
1987

1990
1988
1989

1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016e

Bank Negara Malaysia, Budget 2017

...subsequent pick up expected. The development expenditure of RM45bn for 2016 …this could pick up strongly
and RM46bn for 2017 implies a balance RM169bn to be spent for 2018-2020 from the from 2018 onwards
11MP’s allocation. Assuming the remaining sum is spread equally over 3 years, this
translates to RM56bn p.a., representing a strong potential jump of 22% from 2017.

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Figure #3 Allocation under 11MP (RM bn)

2016
45
17%

2017
46
18%
2018-2020
169
65%

11MP, Budget 2016-2017

Construction outperformance to continue. Fuelled by the implementation of various Construction GDP expected
projects under the Economic Transformation Program (ETP), real construction growth to continue outperforming
has outperformed overall GDP since 1Q12. Our economics team is projecting 2016 overall GDP in 2017
real construction growth of 8.1% vs overall GDP expansion at 4.2%. For this year,
outperformance of construction growth is expected to be sustained, at 10% against a
backdrop of overall GDP forecast at 4.5%. This view is also echoed by the Ministry of
Finance which projected real construction growth of 8.3% (GDP: 4.6%).

Figure #4 Real construction output vs GDP (% chg YoY)

25%
Construction GDP
20%

15%

10%

5%

0%
1Q06
3Q06
1Q07
3Q07
1Q08
3Q08
1Q09
3Q09
1Q10
3Q10
1Q11
3Q11
1Q12
3Q12
1Q13
3Q13
1Q14
3Q14
1Q15
3Q15
1Q16
3Q16

-5%

-10%

Bank Negara Malaysia

Contract flows to normalise

2016 was a record year. Based on our tracking of domestic contract awards to listed
contractors, job flows for 2016 came in at a record RM56.4bn. This amount was a Last year was a record for
significant YoY increase of +158% from 2015 and also surpassed the previous high of contract flows at RM56bn
RM28bn achieved in 2012. In terms of contribution, the strong job wins in 2016 largely (+158% YoY).
came from the MRT (mostly from MRT2) at RM24.3bn (43%). Apart from that,
contracts from the Pan Borneo Sarawak totalled RM10bn (18%) while other major
highways summed to RM7.6bn (13%).

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Figure #5 Domestic contract awards to listed contractors (RM bn)

60 56.4

50

40

30 28.0

21.9
20 17.9
15.6 15.4
11.9
10.0
10

0
2009 2010 2011 2012 2013 2014 2015 2016
HLIB compilation from Bursa announcements

Figure #6 Breakdown of 2016 domestic contract awards (RM m)

Pan Borneo
10,043 Highways
18% 7,583
13%

MRT2 &
others
8,805
16%
Others
14,515
26%

MRT2
underground
15,470
27%

HLIB compilation from Bursa announcements

Expect a normalisation this year. Given the significantly high base achieved in 2016, Given the high base in 2016,
it would only be rational to expect a downward normalisation in contract flows this year. expect a downward
This is in view of (i) most of the packages for major contracts such as the MRT2 and normalisation this year.
Pan Borneo Sarawak have already been dished out and (ii) upcoming mega projects
slated for 2017 (e.g. LRT3) are unlikely to match last year in value terms. As such, for
2017, we expect domestic contract flows to listed contractors to total RM25bn. While
this represents a -56% YoY decline (or rather, normalisation), it is in between the levels
achieved in 2012 (RM28bn) and 2015 (RM22bn), which were also relatively strong
years for contract flows.

Key projects to eyeball for 2017

Remaining packages of MRT2. Roughly 85% of the MRT2 contracts have been
RM5bn remaining packages
awarded and the indicative value of the entire project is estimated at RM32bn. Based
on this, there should be another RM4.8bn worth of MRT2 related contracts to be for MRT2
awarded in 2017, which will mostly be out in 1H. The tender schedule provided by
MRT Corp indicates that some of the remaining sizable contracts include (i) 3 viaduct
packages for the elevated section, (ii) 9 station packages and (iii) 3 noise barrier
packages. While still in its early days, the alignment studies for the MRT3 (a circle
line), is nearing completion and could be rolled out by end-2018.

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Figure #7 Alignment for MRT2

MRT Corp

Awaiting LRT3 rollout. At a cost of RM9bn, the LRT3 will span 37km from Bandar LRT3 contracts to be dished
Utama to Klang with a total of 26 stations, 5 of which will be integrated with other rail out in 1Q17
lines. Key areas that will be covered by its alignment include Bandar Utama,
Tropicana, Glenmarie, Shah Alam town centre, Bukit Raja, Klang town centre and
Bukit Tinggi. In Sept 2015, the 50:50 JV between MRCB (HOLD, TP: RM1.37) and
George Kent (BUY, TP: RM3.77) was awarded the PDP role. The PDP has indicated
there will be 15 main civil packages up for grabs this year, with the initial awards in 1Q.
In our view, contractors that have a track record with the LRT extension and MRT1 are
potential candidates for the LRT3 works. However, we would like to highlight (i)
SunCon (BUY, TP: RM1.93) given its commendable execution of the LRT extension,
BRT Sunway line and MRT1 and (ii) Mitrajaya (BUY, TP: RM1.95) which has
undertaken 8 stations for the LRT extension.

Figure #8 Proposed alignment of the LRT3

Prasarana

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Greater KL’s catalytic developments. There are several catalytic developments Greater KL’s catalytic
being implemented in Greater KL, commanding a total GDV of at least RM275bn over developments expected to
3,355 acres of land. These include the Tun Razak Exchange (TRX), Warisan Merdeka, generate RM138bn worth of
Bukit Bintang City Centre (BBCC), Bandar Malaysia, Kwasa Damansara and construction works
Cyberjaya City Centre (CCC). All of these developments have government
participation as the master developer, be it directly or indirectly via its related entities
(e.g. EPF and PNB). As such, we reckon that much effort (e.g. tax incentives) will be
accorded to ensure the success of these developments. Assuming construction cost
constitutes 50% of GDV, these catalytic developments would present RM138bn in
potential jobs to contractors. Potential construction beneficiaries include earthworks
specialists such as WCT (HOLD, TP: RM1.99) and Gadang (not-rated). Apart from
that, contractors such as IJM (BUY, TP: RM3.92), Pesona (BUY, TP: RM0.81),
Mitrajaya and SunCon have all undertaken several urban high rise buildings. We also
highlight pilling such as Econpile, Pintaras Jaya and Ikhmas Jaya (all non-rated) as
potential beneficiaries of Greater KL’s catalytic developments.

Figure #9 Greater KL’s catalytic developments

Development Master Developer Acres GDV (RM bn)
Tun Razak Exchange MoF via TRX City 70 40
Warisan Merdeka PNB 19 5
Bukit Bintang City Centre Eco World (40% ), UDA (40% ), EPF (20% ) 19 9
Bandar Malaysia IWH-CREC (60% ), MoF (40% ) 486 160
Kwasa Damansara EPF via Kwasa Land 2,620 50
Cyberjaya City Centre MRCB (70% ), MoF via Cyberview (30% ) 141 11
3,355 275
Media sources, development websites

Mammoth ECRL to kick off. It was announced during Budget 2017 that the mammoth M’sia and China sign
RM55bn East Coast Rail Link (ECRL) would be implemented. This was followed by the agreement for ECRL
signing of a financing and EPC agreement between Malaysia and China on Nov 2016.
Under the agreement, (i) the latter would provide financing for the project via Export-
Import Bank of China and (ii) state owned China Communications Construction
Company (CCCC) will lead the construction works. The 620km ECRL will connect
townships such as Port Klang, Gombak, Bentong, Mentakab, Kuantan, Kemaman,
Kerteh, Kuala Terengganu, Kota Bahru and ends in Tumpat. A 50km tunnel will also
be required for the ECRL as its alignment passes the Titiwangsa mountain range. It
was reported that the project will start this year and end in 2022.

Subcontract opportunities for locals. While CCCC will lead the construction works,
we see ample opportunities for local contractors to participate via subcontracts. Track ECRL will benefit locals via
record wise, Gamuda (BUY, TP: RM5.67) stands out as the ultimate beneficiary given subcontracts
its experience with the Northern Electrified Double Track (EDT) (RM12.5bn) which also
involved the 2.5km Berapit Tunnel through the mountain. Apart from that, names such
as IJM and Fajarbaru (not-rated) have undertaken the mid-south section of the EDT
via subcontracts from India-based Ircon.

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Figure #10 Proposed alignment of the ECRL

SPAD

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Valuation & Rating

Rating proven right for 2016. Despite being a record year for contract flows, the KL
Construction Index rose only marginally (+3%) in 2016. This we believe was largely
dragged by weakness in the broader market with the KLCI declining by -3% last year.
Nonetheless, on a relative basis, the KLCON still outperformed the KLCI by +6%,
proving our Overweight rating on the sector to be correct.

Figure #11 Relative performance between KLCON and KLCI

108

106

104

102

100

98

96

94
KLCI KLCON
92

90
Nov-16

Dec-16
Oct-16
Apr-16

Jul-16
Jan-16

Jan-16

Jun-16
Mar-16

Aug-16

Sep-16
Mar-16

May-16

Bloomberg

Maintain OVERWEIGHT for 2017. Despite our expected downward normalisation in

contract flows for 2017, we retain our OVERWEIGHT rating on the construction sector.
Following the record level of contract flows last year, the orderbook levels of most
contractors under our coverage have scaled to new highs. To elaborate further, the
average orderbook cover ratio (i.e. orderbook balance / trailing construction revenue)
within our coverage now stands at 5.5x compared to the usual 2.0-2.5x during previous
periods of normalised contract flows. The significant expansion in cover ratio is
expected to propel earnings growth once execution on the orderbook takes place. In
short, 2017 is expected to be a year of earnings delivery for contractors.

Figure #12 Orderbook cover ratio comparison

GKent 14.5
Pesona 9.1
MRCB 8.5
Gamuda 7.3
IJM 5.7
WCT 3.8
HSL 3.5
SunCon 2.5
Kimlun 2.0
Mitrajaya 1.8
Eversendai 1.5

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

HLIB estimates

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Top Picks
Amongst the large caps, Gamuda (BUY, TP: RM5.67) is our top pick as it is set to
witness a revival in its earnings upcycle for FY17 and potentially hit a new high in
FY18. Over the near term, earnings will be driven by the MRT2 where the MMC-
Gamuda JV is undertaking both the tunnelling (RM15.5bn) and PDP role (RM16.5bn).
Looking ahead, alignment studies are being concluded for the MRT3 circle line and
this could potentially kick off sometime in late-2018 to 2019. Another catalyst would be
the approval for the mammoth RM45bn Penang Transport Masterplan (PTMP) which is
now seeking regulatory approvals. The conclusion of the long drawn water saga via
the sale of 40% owned SPLASH (expected in 2Q17) could potentially raise RM1bn for
Gamuda which would be used to fund the PTMP.

For the mid-small caps, we like George Kent (BUY, TP: RM3.77) as a key rail play
with exposure to the LRT ext, LRT3 and MRT2. Its financials are also solid with 3-year
earnings CAGR of 28%, above industry ROE of 21% and net cash position of
RM0.58/share. Within this space, we also highlight Pesona Metro (BUY, TP: RM0.81)
as it offers investors exposure to a pure construction play with an incoming stream of
recurring income via the acquisition of a hostel concession. It has boasts a 3-year
earnings CAGR of 61%, expanding ROE and net cash position.

Figure #13 Peer comparison

Mkt Cap Price Target P/E P/B ROE Yield
Stock Rating FYE
(RM m) (RM) (RM) CY16 CY17 CY16 CY17 (CY17) (CY17)
Gamuda 12,001 4.95 5.67 BUY July 18.5 16.6 1.7 1.6 9.9% 2.4%
IJM 12,073 3.35 3.92 BUY Mar 23.4 19.7 1.3 1.3 6.5% 2.0%
WCT 2,294 1.83 1.99 HOLD Dec 23.0 15.8 0.9 0.8 5.4% 3.2%
MRCB 2,959 1.38 1.37 HOLD Dec 53.3 41.4 1.2 1.2 2.9% 0.7%
Edgenta 2,719 3.27 3.85 BUY Dec 15.4 14.0 1.9 1.8 13.4% 4.4%
SunCon 2,185 1.69 1.93 BUY Dec 17.3 15.7 4.2 3.7 22.2% 2.9%
Eversendai 476 0.62 0.57 HOLD Dec 9.4 7.9 0.4 0.4 5.0% 2.5%
Kimlun 667 2.15 2.66 BUY Dec 9.1 8.9 1.3 1.2 13.7% 2.2%
Hock Seng Lee 907 1.65 2.00 BUY Dec 14.0 11.5 1.3 1.2 10.6% 2.2%
Mitrajaya 863 1.29 1.95 BUY Dec 8.7 7.9 1.5 1.4 18.2% 4.4%
GKent 1,149 3.06 3.77 BUY Jan 16.8 14.6 3.2 2.9 21.1% 3.4%
Pesona 403 0.62 0.81 BUY Dec 21.5 12.9 2.7 2.4 19.8% 3.3%
HLIB estimates
For companies with non-Dec FYE, financials have been calendarised.

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Disclaimer

The information contained in this report is based on data obtained from sources believed to be
reliable. However, the data and/or sources have not been independently verified and as such,
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reliability of the info or opinions in the report.
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be at your own risk. Hong Leong Investment Bank
Berhad (10209-W)
Level 23, Menara HLA
1. As of 10 January 2017, Hong Leong Investment Bank Berhad has proprietary interest in the No. 3, Jalan Kia Peng
following securities covered in this report: 50450 Kuala Lumpur
(a) -. Tel 603 2168 1168 / 603 2710 1168
Fax 603 2161 3880
2. As of 10 January 2017, the analysts, Jeremy Goh, who prepared this report, have interest in
the following securities covered in this report:
(a) -.

Equity rating definitions

BUY Positive recommendation of stock under coverage. Expected absolute return of more than +10% over 12-months, with low risk of sustained downside.
TRADING BUY Positive recommendation of stock not under coverage. Expected absolute return of more than +10% over 6-months. Situational or arbitrage trading opportunity.
HOLD Neutral recommendation of stock under coverage. Expected absolute return between -10% and +10% over 12-months, with low risk of sustained downside.
TRADING SELL Negative recommendation of stock not under coverage. Expected absolute return of less than -10% over 6-months. Situational or arbitrage trading opportunity.
SELL Negative recommendation of stock under coverage. High risk of negative absolute return of more than -10% over 12-months.
NOT RATED No research coverage and report is intended purely for informational purposes.

Industry rating definitions

OVERWEIGHT The sector, based on weighted market capitalization, is expected to have absolute return of more than +5% over 12-months.
NEUTRAL The sector, based on weighted market capitalization, is expected to have absolute return between –5% and +5% over 12-months.
UNDERWEIGHT The sector, based on weighted market capitalization, is expected to have absolute return of less than –5% over 12-months.

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