Construction sector strong despite rising risk premiums

PETALING JAYA: AmBank Research has maintained its overweight call on the construction industry even as it considers risk premiums to have risen, triggered largely by MRT Corp’s move to introduce a “build and finance” model for MRT3.

The research firm analyst Joshua Ng opined that the model gives an upper hand to foreign contractors with strong financial backing from their governments i.e. the Chinese and Japanese.

The situation is exacerbated by investors increased cautiousness towards construction stocks ahead of the 14th general election, as construction stocks are generally perceived to be vulnerable to policy changes.

The construction index hit a low of 310.50 points before closing 0.2 points lower to 311.83 points yesterday.

Ng stated that the build and finance model is not new in Malaysia, listing the RM4.5 billion Second Penang Bridge and the RM1.3 billion Pahang-Selangor Raw Water Transfer Tunnel project as examples of projects in recent years, however it could lead to local contractors falling further down the food chain in terms of jobs, thus affecting the value and margins for locals.

Citing the structure seen for the East Coast Rail Link job, Ng said the Chinese main contractor China Communications Construction Co (CCCC) subdivided the project into a number of large packages and awarded all but one to its subsidiaries.

The subsidiaries will then subdivide their respective work packages further and parcel out part of them to Malaysian contractors. In other words, Malaysian contractors can only, at best, become second-line subcontractors to CCCC for the ECRL project. The exception to the scenario is only if CCCC decides to award the remaining large package directly to a Malaysian contractor.

“While seemingly negative, we do not believe the latest development warrants a downgrade to the construction sector. The sector’s earnings prospects remain strong with most players sitting on record order books, thanks to the rollout of the Pan Borneo Sarawak highway (RM16 billion), MRT2 (RM32 billion) and LRT3 (RM12 billion) in recent years,” Ng said in his note to investors.

Key risks for the sector include the government is to embark on an austerity drive, resulting in mega and basic infrastructure projects being scaled down, postponed or cancelled; escalation in key input costs, particularly, steel and labour; liquidated and ascertained damages due to late delivery (arising from labour shortage, delays in construction site handover, construction site mishaps, unforeseen ground conditions, challenges in relocation of utilities and traffic diversion); and legal disputes with clients, subcontractors or suppliers.

AmBank Research’s top buys are Gamuda Bhd (expertise in tunnelling and resilient property profits), Sunway Construction (involvement in all key mega projects such as the MRT2 and LRT3, and recurring internal jobs), Kimlun Corp Bhd (supply of concrete segments to rail projects including potentially the ECRL and attractive valuations) and Protasco Bhd (recurring incomes from road maintenance concessions and attractive dividend yield).