Green shoots of construction revival

  • Business Premium
  • Saturday, 26 Jan 2019

Getting back on track: The construction sector is still in a state of flummox, there will be a lot of re-tendering. It will take time to come back on track.

A slew of contracts is given out, but is it enough to spur the sector?

AFTER a roller-coaster year that saw many reviews and cancellations of major local infrastructure projects following a change in government control, some green shoots have started to sprout within the sector.

Just yesterday, a resolution to the multi-billion-ringgit light rail transit three (LRT3) project seems to have been secured with a new contract signed between government agency, Prasarana Malaysia Bhd, and the main contractors. Similarly, reports had emerged that the government had cancelled another mega-project, the East Coast Rail Link (ECRL), which was previously given to a Chinese party. It is said that this project now will be dished out to local players.

In addition, phase two of the Klang Valley double-track rail upgrade project is expected to start soon, while sub-contracts for the Gemas-Johor Baru electrified double-track rail project are increasingly being dished out.

But is this enough for industry players to believe that a revival is taking off?

Based on checks with industry players, the jury is still out on this, although the slew of contracts recently suggests that there is some hope.

New deal: The LRT3 project is back with a new contract signed between Prasarana and the main contractors.
New deal: The LRT3 project is back with a new contract signed between Prasarana and the main contractors.

“The industry is still in a state of flummox, there will be a lot of re-tendering. It will take time to come back on track, probably only in 2020,” a seasoned construction player tells StarBizweek.

“The new government must remember not to just chop, chop, chop the (construction) jobs to save money... it must remember that the construction industry is responsible for a huge portion of the economic multiplier effect in the country,” he adds.

Sunway University Business School economics professor Yeah Kim Leng says he expects the industry to perform only “about the same or marginally better” this year compared to the last.

There’s no outright revival and no construction boom, Yeah says.

Having said that, he sees an uptick in civil engineering activities as some of the big-sized infrastructure and transportation projects under review last year have received the go-ahead at a lower cost, while selective residential projects in high-demand locations will be implemented as planned by large developers with deep pockets.

“Overall, these civil engineering works and property market shifts will help to stabilise the growth of the construction sector,” Yeah adds.

The LRT3 project is set to be rolled out in the second half of the year with the signing of a new fixed-price contract between Malaysian Resources Corp Bhd and its partner George Kent (M) Bhd with Prasarana. Last year, the mega-project was put on hold for a review.

Then in July last year, the-then newly-elected government approved the continuation of the 36 km track at a final cost that was reduced by 47% to RM16.63bil. The completion date was extended from 2020 to 2024.

Elsewhere, MMC-Gamuda KVMRT (T) Sdn Bhd, a joint venture between MMC Corp Bhd and Gamuda Bhd, has agreed to undertake the underground works portion of the mass rapid transit two (MRT 2) project at a lower cost of RM13.11bil. The overall cost for this was slashed by 21.5% or some RM3.6bil.

Meanwhile, latest reports say the contract for the RM81bil ECRL has been terminated and that compensation will be arbitrated.

It is said the government is still in discussions with China Communications Construction Company Ltd on the compensation amount.

The status of the controversial rail project is still uncertain, as some news reports indicate that the government is seeking to continue it at half the estimated cost.

The ECRL was first approved by the former government in October 2016.

Kenanga Research analyst Adrian Ng says currently, the construction sector lacks catalysts, and he does not see much infrastructure spending from the government after the major cost reduction in the two mega-projects, ie, the LRT 3 and MRT 2.

Still, in a Jan 4 note to clients, Ng wrote that the recent heavy selldown on the sector presents a good opportunity to buy on weakness and bottom-fish selectively.

“We advocate investors adopt a selective stock-picking strategy on stocks that have minimal earnings risk in the near to medium term like Gamuda Bhd and Kerjaya Prospek Group Bhd.”

Kerjaya last month obtained a RM211.6mil contract from PPB Group Bhd to undertake construction works for a proposed mixed development in Sungai Buloh, Petaling Jaya.

More recently, another mid-sized construction firm Bina Puri Holdings Bhd got a RM251.53mil contract to undertake sub-contract works for the electrified double-track project from Gemas to Johor Baru.

Another construction analyst when contacted says what the market is looking for now is a more stable news flow on the direction the government is taking with regard to the construction sector.

“Currently, the talk is all about cost-cutting... not so much pump-priming or maybe we are not there yet,” says the analyst.

What’s certain, he says, is that more emphasis should be given to the building of public amenities like hospitals.

But such contracts on average are lower in value, ranging between RM400mil and RM500mil, as opposed to the billion-dollar infrastructure contracts.

He adds that in the property sector, it’s a Catch-22 situation, whether to build or not to build, given the large overhang issue the industry is facing.

“Certainly, it’s going to be a challenging year with the smaller players having a higher earnings risk,” he warns.

The question of pump-priming

From a big-picture perspective, the dilemma is slowing economies, with risk tilting downwards.

AmBank Group chief economist Anthony Dass says the expected moderate global growth will have some knock-on effect on Malaysia’s exports.

“At the same time, lower public spending arising from the ongoing fiscal consolidation by the government will also weigh on growth.

“Still, with some key indicators showing signs of weakening, the 2019 gross domestic product growth we are projecting at 4.5% can ‘undershoot or overshoot’.

“On that score, economically feasible and viable projects in construction and infrastructure will yield positive returns.”

Dass notes that although the contribution from the construction sector is around 5% of overall economic activity, it nevertheless plays an important role in supporting the economy through forward and backward linkages with other sectors.

“In our input contribution estimation, it showed a reading of 0.35, which means that for every additional ringgit, it creates an additional value of 0.35.”

For example, an additional RM30bil spent in 2019 should raise the potential value-add from this sector by RM10.5bil, he says.

“The catch is that this additional value-add will not be immediately apparent as a typical construction period is two years.”

That said, while pump-priming can have the desirable effect in the short run, it can become less feasible in the long run, say some.

This is because it encourages greater private-sector dependence on government contracts.

Two emerging trends

With players now chasing a smaller pool of contracts, two trends are emerging.

“Interestingly, we are now seeing leading contractors like Gamuda vying for smaller building jobs around RM300mil-RM500mil, which means they are competing against smaller local contractors. At the same time, it is targeting overseas markets that have massive underground infrastructure works such as Taiwan and Singapore,” notes Kenanga’s Ng.

Ng says should more big-cap contractors compete in the smaller-sized space in the future, “we might see consolidation in the sector, as the smaller-sized contractors that are less competitive due to limited resources may struggle for survival”.

While Malaysian contractors are no strangers to overseas ventures, some observers reckon that this route could be pursued more aggressively now to maintain a steady pace of growth over the next couple of years.

The level of success among Malaysian contractors overseas is varied. Some have failed, while some have encountered success.Recall, a handful of local companies suffered massive losses and were burnt a decade or so ago in the Middle East which had at that time, undergone a political and economic crisis.

Some of these firms include WCT Holdings Bhd, which in December 2008 saw a cancelled race-course contract worth RM4.6bil and Muhibbah Engineering (M) Bhd which encountered cost overruns in the carrying out of its US$158.3mil contract to build storage facilities there.

Back to the present time, Gamuda recently said that it would be exploring more overseas jobs in Singapore, Vietnam and Australia.

The company’s exposure to overseas projects has largely been in Vietnam, India and the Middle East.

Sunway Construction Group Bhd has also set its sights overseas and is reportedly eyeing potential projects in Myanmar and Indonesia.

WCT, meanwhile, has one remaining project in Qatar but has said that it will no longer focus on projects in the Middle East.

Shrinking margins

According to Maybank Research, a profit before tax margin of 5%-6% could likely be the new normal for companies. This from an 8%-10% margin previously for government projects.

Last year, the KL Construction Index was down by half its value as opposed to the stock market’s main index’s gain of 7.5%, weighed down by uncertainties and lack of catalysts.

Kenanga’s Ng notes that for financial year 2018, total contracts secured by listed companies only amounted to RM18.9bil, a drastic drop of 48% year-on-year, after the conclusion of the cost review in LRT 3 and MRT 2.

While current valuations suggest the bulk of bad news is already priced in, all eyes will be on the earnings of the companies.

“With a subdued outlook for contract wins this year, earnings delivery and project execution will be crucial to avoid further de-rating,” says one analyst.

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