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Construction — A tale of two cities

Malaysia and Singapore roadshow
After releasing our construction sector piece on July 19, we went on a roadshow in Malaysia and Singapore where we met 55 fund managers (FMs) and buy-side analysts from 28 investment management firms in Malaysia and 13 FMs and analysts from nine firms across the causeway.

We highlighted that the key theme for the construction sector over the 10th Malaysia Plan (10MP) period will be public transportation. The sector could see a big boost if the mass rapid transit (MRT) proposal goes through. Gamuda Bhd would be the biggest beneficiary.

We maintain our view that the MRT proposal has a high chance of being approved, possibly as early as this month. We also gave investors an update of existing mega jobs for which progress has been encouraging since the beginning of the year. This should allay concerns over execution of the projects, which is one of investors' main reservations.

Feedback from investors

How has the scenario changed this time from 2009? Some reservations voiced by the clients we met included potential delays that are typical for large-scale jobs, political will/execution and the availability of funding. We were not surprised by these comments and thought it was a fair observation given what had transpired in 2009.

Sentiment on the sector peaked sometime in October 2009 as expectations of the implementation of the light rail transit (LRT) extension/upgrade and progress of other jobs were running high. However, sentiment on the sector took a hit due to project delays towards the end of the year. We highlighted that progress so far this year has been encouraging and most tenders have progressed to advanced stages.

We observed more project awards in 1H10 compared to 2H09, which suggests an improved outlook for project flows for 2H10. Execution remains the key and is likely to improve. A clearer sense of the funding structure for various high-impact projects, especially the MRT, will be available once the project is approved.

Is the MRT project a 'sure thing'?

Several investors, especially in Singapore, were still unclear about the significance of the MRT proposal and why we believe that it has a good chance to go through. The project value of RM36 billion (excluding rolling stock and other components) makes it the biggest project for the sector so far and a handful of contractors stand to gain.

Gamuda is vying for the RM13 billion-RM14 billion tunnelling portion while the RM25 billion balance of works will be tendered out to local players. The fact that the MRT proposal was one of the deliverables of 10MP reinforces the importance of this project. The MRT proposal is currently being reviewed by two independent consultants and the findings will be presented to the government/Cabinet.

Separately, another review of the public transport masterplan is being conducted by the Land Public Transport Commission (SPAD). This will focus on the implementation plans for both the LRT extension/upgrade and MRT. The latest indication is that the review by SPAD is expected to be completed in September 2010.

In terms of the likely key events for the MRT proposal in 2H10, some investors think that the expected August 2010 timeline for Cabinet approval is too ambitious while some shared our expectation that an approval is most likely to come through before end-2010.

altWhat about the prospects for other jobs?

A few investors were more interested in the chances of the remaining packages of existing projects going through. We highlighted that the progress of other jobs other from the MRT project has seen encouraging progress. The RM7 billion LRT/extension/upgrade is at the tender stage. Contractors which have prequalified are preparing to submit the full proposals to Syarikat Prasarana Negara Bhd (SPNB) by end-August 2010.

We gather that SPNB is looking at two phases for each LRT extension and is looking at positioning two main turnkey contractors on each extension line. The first phase for both the Kelana Jaya and Ampang lines is estimated to be worth RM1.5 billion-RM1.9 billion and is targeted to start work in November 2010.

The new LCCT dished out the biggest package worth almost RM1 billion to Bina Puri-UEM JV recently. The balance of RM350 million for the RM2 billion total package will be for the construction of the runway. There are also other components beyond the original scope which will include a shopping mall, hotel and other commercial plots worth between RM500 million and RM1 billion.

On the progress of the IWTS, investors were pleasantly surprised to learn that two packages have been awarded on the Pahang side and the balance of two more packages worth RM2.2 billion is expected to be awarded by end-2010.

Priority jobs under the RM63 billion high-impact projects?

Among the 52 high-impact projects worth RM63 billion under 10MP, those that are likely to be a priority are the MRT, LRT extension/upgrade, seven highways and two new power plants.

We also would not discount emphasis projects in Sabah and Sarawak, especially those involving rural and water infrastructure. We told the investors that based on our checks, contractors are generally more optimistic compared to six to nine months ago.

Which stocks to look at?

Some investors were already familiar with the MRT story and were more interested in other "laggard" plays in the sector. We recommended WCT, which is one of our top picks for exposure to good newsflow from the Middle East and potential water infrastructure in Sabah.

Although the potential provision from Bakun is still unclear at this point, the RM20 million-RM30 million figure recently talked about is lower than the earlier worst-case estimate of RM99 million. We estimated that it would cut WCT's FY10 earnings by 12%-19% and its target price by 44 sen to RM3.61, which would still offer attractive upside.

There was also interest in IJM Corp, which has so far won several local jobs, bringing it closer to its RM2 billion new order book target by end-2010. Our recent upgrade of MRCB as a thematic play was also generally well received. Other preferences in the sector are skewed towards those with strong fundamentals, growth prospects and attractive valuations like Mudajaya.

Several investors who were more familiar with the Indian power industry agreed with our view that the group is still at the early stages of its growth phase and argued that valuations are not demanding. We think the recent share price reaction to the "poison letter" provides a good entry point.

Valuation and recommendation

The feedback from our roadshow was generally positive. Most of the investors shared our view that the construction sector is still in play, especially after the recent announcement of the 10MP which laid out several high-impact projects. Investors were also keen to know more details of other projects that appear to be on the government's priority list and would be positive for other contractors.

Concerns that consistently surfaced during our meetings were political will/execution and funding. We think those issues will be addressed in the coming months as we expect several awards of key projects to take place.

The big kicker for the sector would be the potential Cabinet approval for the MRT project. We maintain our overweight on the construction sector, with Gamuda and WCT remaining our top picks. — CIMB Research
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