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Construction sector on stronger footing than 2008

Construction sector
We compare the sector now with during the 2008 credit crunch, looking at new orders, earnings visibility, geographical exposure, balance sheet strength and valuations. Overall, we feel this domestic-oriented sector fuelled by the Economic Transformation Programme (ETP) will be less affected by a US recession or Europe debt woes.

Earnings visibility is better now with the RM50 billion Mass Rapid Transit (MRT) project anchoring growth against 2008/09 when the two stimulus packages benefited unlisted smaller contractors more. Margin recovery is stronger with the bulk of legacy order book depleted and quality improved with less exposure to riskier Middle East and India contracts (less than 20% for IJM Corp Bhd and Gamuda Bhd against 40% to 50% in 2009). Average net gearing has fallen to 0.2 times (against 0.4 times in 2009) with stronger operating cash flows.

The RM50 billion MRT project will anchor the construction sector in the next decade. We see minimal risk of delays given the slowing local economy and impending general election. Construction is often used to lift GDP growth because of the large multiplier effect. The MRT is expected to contribute RM8 billion to RM10 billion a year to GNI based on 2.5 to 3.5 times multiplier. Some 28 contractors have pre-qualified for the elevated portion comprising civil works, stations and depots. The stronger contenders appear to be IJM, TRC Synergies Bhd and Sunway Group which have been pre-qualified for all portions.

During 2008/09, the KL Construction Index tested two standard deviations below mean against 15 times price-earnings ratio (PER) and 1.3 times price-to-net tangible assets currently (mean levels). It is unlikely to test those again given support from the ETP and lower foreign ownership. A better comparison would be sum-of-parts valuation; our bear case for Gamuda is RM3.30 per share (No MRT and Vietnam) and IJM RM6.70 per share (lower order wins and PER), which still offer 14% and 17% upside. Key risks would be the ruling coalition losing more ground in the general election, which could stall the MRT, and still high average foreign shareholding of 20% (but below 2007 peak of 41%). Our top pick remains IJM as a strong diversified proxy whose order book will peak at RM9 billion by end-2011. Gamuda (at 2008 recession low), WCT Bhd and Malaysian Resources Corp Bhd are also large laggards. — HwangDBS Vickers Research, Sept 14

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