Stronger pulse detectedin construction sector

The Edge Daily

ASEAMBANKERS Equity Research says government development spending should accelerate after having fallen behind — with only 25.4% of the RM200b development allocation for the 9MP period (2006-10) spent to-date.

“With at least RM165 billion worth of infrastructure and development projects identified by the government and private sector, we foresee a sectoral boom at the turn of this decade, if all works take off on time,” it said.

In the report released yesterday, the research house remains positive over the prospects of the construction sector.

Its top picks are Gamuda, WCT Engineering, Hock Seng Lee and Loh & Loh. It also likes Sunway Holdings Inc and Ann Joo Resources.

Stronger momentum ahead
We expect government development spending to accelerate with only 25.4% of the total development allocation for the 9MP period spent as at mid-August 2007. In terms of yearly spending, only 90% of the development allocation for 2006 has been spent, while for 2007, only 33% has been spent.

For 2008, government development expenditure is expected to be marginally lower by 2.1% to RM40b, while construction sector real GDP is expected to grow by 6.3%. Presumably, Private Finance Initiative (PFI) projects would take off in a more meaningful way to fuel sectoral growth in 2008, while project awards by the government and implementation would also accelerate.

Entering another construction boom?
The country could enter another construction boom if all proposed projects (including private sector projects and those under PFI) are to take off on time. We note that at least RM165 billion worth of infrastructure and development projects have already been identified by the government and the private sector, which are expected to kick off by the turn of this decade.

The last construction sector peak was in 1994-96, led by buildings and transportation-related construction jobs. This time around, we foresee high impact and chunkier projects in the rail, water, and oil & gas sectors, and the government’s regional development efforts, to be the key drivers.

Benefiting the construction and building material boys
We therefore remain positive over the prospects of the construction sector. We continue to favour contractors with niches and long-drawn experience, good delivery track records, proven management and healthy balance sheet.

Our top picks are Gamuda, WCT Engineering, Hock Seng Lee and Loh & Loh. We also like Sunway Holdings Inc with businesses in construction, building materials and quarry.

Filtering down to the building material boys, our pick is Ann Joo Resources. Amid uncertainties on the external front which may derail the country’s economic growth path, and with a general election looming in the near horizon, we are of the view that the downside risks for construction-related stocks should be quite limited, while positive news flows for new project awards and implementations should provide the upside potential.

Higher momentum ahead
RM57b new jobs targeted for 2007 (up 3.4% year-on-year). After 10 consecutive quarters of negative growth, the construction sector rebounded mildly in 4Q06 with a 0.6% YoY growth in real output, and the momentum strengthened into 2Q07, with a 4.8% YoY growth.

Our compiled list of new jobs announced by public listed construction groups showed that there were RM20.3 billion new local jobs for the year to-date, of which 37% were government and the balance were private sector / privatisation jobs.

This was quite in line with official records, where the value of new local jobs reported to the Construction Industry Development Board (CIDB) was RM19.5 billion in 1H07 (CIDB records also include new jobs secured by non-listed contractors).

With 1H being seasonally slower in nature, the momentum of awards should pick up in 2H07. CIDB targets RM57 billion new jobs for the construction sector in 2007, up 3.4% YoY (2006: +3% YoY to RM55.1 billion).

Still a way to catch up on 9MP implementation.

Of the RM200 billion allocation for development spending by the government under the Ninth Malaysia Plan (9MP) period (2006-10), only 25.4% had been spent as at mid-Aug 2007, which implies that spending has been behind schedule.

In terms of yearly spending, of the RM35.8 billion development allocation for 2006, only 90% had been spent, while of the RM45.1b allocation for 2007, only 33% had been spent.

Consequently, actual development spending for 2007 is projected to be only RM40.9 billion in the recently released Economic Report 2007/08, compared with RM45.1 billion allocated or budgeted for the year.

We expect government development spending to accelerate, lest targets under the 9MP not be met.

Ninth Malaysia Plan: Progress Snapshot
The 9MP comprises two components of spending: i) development spending by the government (RM200 billion), and ii) Private Finance Initiative (PFI) projects (RM20 billion).

The total RM220 billion in turn, comprises allocations for: i) physical hard infrastructure (RM145 billion or 66% of total; 24,637 projects), and ii) soft infrastructure (RM75 billion ; 6,205 projects).

Hard infrastructure. 9MP allocations are as follows:

Projects Allocation(RM bln)% of total No. of projects
Building 109.0 75.2% 23,045
Roads, bridges & drainages 28.7 19.8% 1,405
Airports & railways 7.3 5.0% 187
Total 145.0 100.0% 24,637

PFI projects. The entire RM20 billion PFI spending under the 9MP blueprint is for building works comprising 902 projects, where the initial funding would come from the Employees’ Provident Fund.

This group of PFI projects are termed as the “PFI –1” projects. A special purpose vehicle called PFI Sdn Bhd, a 100%-subsidiary of Minister of Finance Inc, will play a central role in project implementation.

“PFI-2” projects are those whose funding would be sourced by the project proponents. The total value of these PFI-2 projects is not included in the development spending under the 9MP blueprint. These include projects like the revived double-tracking rail project (northern section) awarded to MMC-Gamuda, but whose PFI terms have yet to be finalised.

PFI jobs expected to lead sectoral growth in 2008
For 2008, government development expenditure is expected to be marginally lower by 2.1% to RM40 billion under the Economic Report 2007/08 (2007: +14.1%).

Meanwhile, construction sector real GDP is estimated to grow by 6.3% in 2008 (2007: +5.2%). Presumably, PFI projects would take off in a more meaningful way to fuel sectoral growth in 2008. While Budget 2008 offered no new major infrastructure projects, presumably, project awards by the government and project implementations would also accelerate from 2008.

Entering another construction boom?
At least RM165 billion projects are identified. This would be the case if all identified infrastructure and development projects (including private sector and PFI projects, and projects under the five corridors of economic development, namely, Iskandar Development Region, Northern Corridor Economic Region, East Coast Economic Region, and Sabah and Sarawak Economic Regions) are to take off.

The critical question is, of course, the implementation timeline which could lead to a sectoral boom at the turn of this decade. We note that at least RM165 billion worth of such projects have been already identified by the government and the private sector, and are expected to kick off by the turn of this decade. We believe this could lead to a construction sector boom at the turn of this decade, if all works are to take off on time.

Driven by projects in the rail, water, oil & gas sectors, and regional developments. The last sector peak was in 1994-96, with major projects being the KL City Centre, KL International Airport, KL LRTs and intra-urban expressways — essentially, buildings and transportation-related construction projects.

This time around, we foresee high impact and chunkier projects in the rail, water, and oil & gas sectors and the government’s regional development efforts to be the key drivers.

Positive on construction sector prospects
Putting things into perspective, we remain positive over the prospects of the construction sector, with accelerating government development spending, and abundant infrastructure and development projects including those under the PFI and regional development initiatives. Thus far, details of only two regional development efforts have been unveiled, while details of the East Coast, Sabah and Sarawak Economic Regions will be made known by end-2007.

High impact jobs to lead momentum. We expect high-impact projects like the double tracking rail, Pahang-Selangor water transfer and Bakun undersea cable project to lead the momentum for sectoral growth into 2010 and beyond.

Top picks
Top on the list of beneficiaries are contractors with niches and long-drawn experience, good delivery track records and strong balance sheets. Our top picks are Gamuda, WCT Engineering, Hock Seng Lee and Loh & Loh.

Gamuda, having built up an impressive track record for large scale and innovative infrastructure jobs, particularly in water infrastructure and tunnelling works, is a main beneficiary for works in the rail, water, sewerage and flood mitigation segments.

WCT Engineering’s edge is in its lean cost structure, which has enabled it to put in very competitive bids. It has built up considerable experience in East Malaysia and Middle East construction in the areas of building and infrastructure works (roads, airport, water) and specialised projects (i.e. Formula One circuits).

Hock Seng Lee, a home-grown Sarawakian contractor with a niche in marine engineering (land reclamation), also offers civil engineering and infrastructure works (roads, ports, airports). It should benefit from the government’s development efforts for Sarawak.

Loh & Loh Corp is a strong contender for water infrastructure jobs, having constructed 13 major dams, 30 water treatment plants and more than 30 reservoirs throughout the country. It is also experienced in bulk earthworks, and rail track construction.

In addition, we also like SunInc, which has core businesses in construction, building materials and quarrying. The group should return to stronger footing with the discharge of its obligations for bonds at SunInfra, potential construction jobs and a new contract to supply stones to Singapore.

Other potential beneficiaries are IJM Corp, UEM Builders, MTD ACPI Engineering, and Muhibbah Engineering. We also believe that the ECER will throw more limelight on Ahmad Zaki Resources, which has a strong foothold in Terengganu, and should also benefit from O&G related infrastructure works there via its equity stake in Eastern Pacific Industrial Corp.

Building material boys to benefit too. In addition, building material players should benefit from the rise in construction activities. Two direct beneficiaries are the cement and steel boys. Potential beneficiaries in the cement industry are Lafarge Malayan Cement, YTL Cement and Cement Industries of Malaysia, while likely beneficiaries in the long steel products are Kinsteel, Lion Industries, Southern Steel and Ann Joo Resources.

Our pick among the steel companies is Ann Joo Resources, which is transforming itself into an efficient full-fledged steel producer with the commissioning of Malaysia’s first mini blast furnace in 2008.

This venture would form the first phase of Ann Joo’s longer-term transformation plans into a leading steel player in Asean.

Steel sector outlook
Expect steel prices worldwide to remain firm, 2006 was a strong year for steel usage worldwide with a growth of 8.5%. The International Iron and Steel Institute (IISI) forecasts continued growth in steel usage by 5.9% in 2007 and 6.1% in 2008, with China remaining as the largest single market and strongest growth area. Steel usage in China is predicted to rise by 13% in 2007, and 10% in 2008, making up 35% of total world steel demand.