Construction to outperform GDP growth in 2017

Construction sector

Maintain overweight: Development expenditure for 2017 has been set at RM46 billion, which is flattish at +2% year-on-year (y-o-y). This should help sustain nominal construction output given its strong correlation (73%) to development expenditure.

The 11th Malaysia Plan from 2016 to 2020 has an allocation of RM260 billion, 13% higher than the 10th Malaysia Plan. Subtracting the RM45 billion allocation for 2016 and RM46 billion for 2017, it leaves a balance of RM169 billion for 2018 to 2020. Assuming this is spread equally over three years, spending momentum could pick up strongly in 2018 by +22% to RM56 billion.

The outperformance continues in which the real construction growth has outperformed overall gross domestic product (GDP) since the first quarter of 2012 (1Q2012). Our economic team expects the outperformance of construction to persist in 2017 at 10% against an overall GDP growth of 4.5%.

It is a year of normalisation, in which 2016 witnessed a record showing of contract flows at RM56 billion, which was up +158% y-o-y and also surpassed the previous high of RM28 billion in 2012. Coming from a significantly higher base, it would only be rational to expect a downward normalisation of job flows for 2017 and we expect this to come in at RM25 billion.

The rollouts for the year expected with the mega projects in 2017 include the remaining packages of the mass rapid transit Line 2 (MRT2) in the first half of 2017, light rail transit Line 3 (LRT3) awards to begin in 1Q2017 and potentially the mammoth East Coast Rail Link towards end-2017 at the earliest.

Several catalytic developments have emerged in Greater Kuala Lumpur, which include Tun Razak Exchange, Warisan Merdeka, Bukit Bintang City Centre, Bandar Malaysia, Kwasa Damansara and Calvary Convention Centre. Collectively, these developments have a gross development value of at least RM275 billion and can potentially generate RM138 billion worth of works for contractors to undertake.

The key risk is a softening domestic property market which may see slower job flows from private-sector developers.

While we expect a downward normalisation of 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.

Gamuda Bhd is our top pick among large-cap contractors as it is set to see a revival of earnings growth in 2017 and potentially a new high in 2018. Catalysts include the MRT3, the Penang Transport Master Plan and the sale of Syarikat Pengeluar Air Sungai Selangor Sdn Bhd. We maintain our “buy” call with a target price (TP) of RM5.67.

Despite our expected downward normalisation of contract flows for 2017, we retain our “overweight” rating on the construction sector. Following the record level of contract flows last year, the order-book levels of most contractors under our coverage have scaled to new highs. To elaborate further, the average order-book cover ratio (order-book balance/trailing construction revenue) within our coverage now stands at 5.5 times compared with the usual two to 2.5 times during previous periods of normalised contract flows. The significant expansion in cover ratio is expected to propel earnings growth once execution of the order book takes place. In short, 2017 is expected to be a year of earnings delivery for contractors. — Hong Leong Investment Bank, Jan 10

This article first appeared in The Edge Financial Daily, on Jan 11, 2017. Subscribe to The Edge Financial Daily here.