Construction sector downgraded, lower margins seen

UOB Kay Hian noted that post the 14th General Election (GE14) that saw Pakatan Harapan (PH) taking over the Federal Government, most construction and highway-concession related stocks have tumbled significantly, besieged by concerns of potential cancellation/deferment of some mega projects, contract renegotiation of ongoing mega projects, and toll road concessionaires being compromised.

PETALING JAYA: Lower-than-anticipated margins will become the new normal for contractors as they compete for new projects in the near term, due to more prudent spending by the government, said UOB Kay Hian Research.

The research house, which downgraded the sector to underweight, said margins were now expected in the range of 5%-6% compared to 8%-10% previously.

AmBank Research has also downgraded the sector to underweight from neutral.

The Pakatan Harapan government, since coming into power earlier this year, has reviewed most mega infrastructure projects for feasibility and costs, resulting in some being shelved and some being allowed to continue following a cost review.

UOB Kay Hian Research singled out the disagreement between the government and Gamuda on the construction of the mass rapid transit 2 (MRT2) project, which was resolved with Gamuda and its partner MMC Corp continuing the construction of the remaining 60% of the underground tunnel project at a lower cost, via a reduced scope of work coupled with lower margins.

“For most of the contractors who rely heavily on government tenders, their order books are depleting as progress billings are recognised, but they are unable to replenish order books,” it said in a note yesterday.

To sustain earnings, it said, some contractors have diversified to focus on order book replenishment from parent or sister companies, such as Sunway Construction from Sunway Bhd, and WCT Holdings from Impian Eksperesi.

Other contractors are monetising their idle land banks for property development, such as Gabungan AQRS and Gamuda.

“This strategy may cushion the ‘foregone earnings’ from replenishment and provide earnings visibility in the near term.

“However, the contract flows from this strategy may not be enough to offset the loss of government projects for certain contractors as government tenders are usually sizeable,” it said.

The research house expects investors to remain cautious in the near term amid negative newsflow in the construction space, such as the termination of the MRT2 underground contract as well as fewer jobs in the market next year.

It noted that projects considered top priority included the Pan Borneo Highway project in Sabah and Sarawak, which could benefit Gabungan AQRS, which are among the frontrunners as well as the Klang Valley Double Track 2 project.

On the latest reporting season, it noted that most contractors’ earnings missed expectations, with the exception of Ekovest Bhd and Gamuda Bhd.

“Key culprits against our forecasts were largely the slower-than-expected progress billings of government infrastructure related projects such as the LRT3, while billings of current outstanding jobs are still in the early stages, resulting in lower billings recognition,” it said.