We maintain our OVERWEIGHT stance on the construction sector, premised on the Government’s strong commitment towards public infrastructure spending under the 11thMalaysia Plan (11MP) and a long list of mega infrastructure, property and industrial projects, indirectly funded by the Government. Our Top Picks are Gamuda, IJM Corp, Kimlun Corp and Pintaras Jaya.

Higher development expenditure under the 11MP. The development expenditure under the 11MP is projected at MYR260bn, which is up 16% vis-à-vis the estimated MYR223.6bn incurred during the 10th Malaysia Plan (10MP). Among the key recipients of the development allocation are roads, rural water and electricity supply, and public housing.

Plenty of mega projects indirectly funded by the Government. Going hand-in-hand with these development expenditure-funded projects is a long list of mega infrastructure, property and industrial projects. These projects are largely financed by the national oil company, the national sovereign wealth fund, government-owned special purpose vehicles (SPVs), government-linked companies (GLCs) or the private sector.

Urban public transport a key focus area under the 11MP. Rail-based mass transit networks will eventually take over the existing land-based road networks as the backbone of the public transportation system in densely-populated areas like the Klang Valley and Penang. Industry players are bracing for a busy time ahead with the almost concurrent implementation of mass rapid transit (MRT) 2, light rail transit (LRT) 3, Penang Transportation Master Plan and more bus rapid transit (BRT) projects.

Key risks: i) the Government may cut back on public infrast ructure spending on weaker oil and gas revenue, and ii) a prolonged slowdown in the property sector.

We maintain our OVERWEIGHT stance on the construction sector.Our bullish stance on the construction sector is reaffirmed by the Government’s commitment towards public infrastructure spending under the 11MP. Our Top Picks are Gamuda (GAM MK, BUY, TP: MYR5.26) –given its dominance in the Klang Valley MRT project, IJM Corp (IJM MK, BUY, TP: MYR7.84) – with its record MYR7bn construction orderbook and substantial in-house jobs, Kimlun Corp (KICB MK, BUY, TP: MYR1.65) – given its position as a major supplier of MRT concrete segments, and Pintaras Jaya (PINT MK, BUY, TP: MYR4.60) – based on its strong presence in the piling segment.

A Busy Time Ahead Strong commitment towards public infrastructure spending The development expenditure under the 11MP is projected at MYR260bn, which is up 16% vis-à-vis the estimated MYR223.6bn incurred during the 10MP. Meanwhile, real construction GDP is projected to grow at a CAGR of 10.3% during the 11MP, which is broadly in line with 11.1% achieved during the 10MP. Among the key recipients of the development allocation are roads, rural water and electricity supply and public housing (see Figure 1).

Going hand-in-hand with these development expenditure-funded projects is a long list of mega infrastructure, property and industrial projects. These are largely financed by the national oil company, the national sovereign wealth fund, government -owned SPVs, GLCs or the private sector. These include Iskandar Malaysia (MYR383bn), the Sarawak Corridor of Renewable Energy (SCORE) (MYR334bn), the Refinery and Petrochemical Integrated Development (RAPID) project (MYR89bn), the Klang Valley mass rapid transit (MRT) (MYR80bn), the Kuala Lumpur-Singapore high-speed rail (MYR40bn), Penang Transport Master Plan (MYR27bn), the light rail transit 3 (LRT3) (MYR9bn) and West Coast Expressway (WCE) (MYR5bn) (see Figure 2).

Urban public transport a key focus Urban public transport is a key focus area under the 11MP as 75% of the population in Malaysia will live in cities by 2020. The 11MP sets a 40% public transport modal share in the Klang Valley by 2020 from 17.1% in 2014. This is consistent with ourview that spending on mass rapid transit developments will be one of the key pillars of support for the construction sector in Malaysia over the next decade and beyond, particularly in the Klang Valley and Penang. Rail -based mass transit networks will eventually take over the existing land-based road networks as the backbone of the public transportation system in densely-populated areas like the Klang Valley and Penang. This is as Malaysia marches towards a developed nation status. Industry players are bracing for a busy time ahead with the almost concurrent implementation of MRT2, LRT3, Penang Transportation Master Plan and more BRT projects (see Figure 3).

Key risk – dependence on public spending and the property sector Generally, fortunes of construction companies are tied closely to government infrastructure spending and the strength of the property sector, as they are the main sources of new jobs for construction companies.

There is a concern that the Government may cut back on public infrastructure spending on falling oil and gas revenues. The mitigating factors are: i) the availability of a new income source to the Government with the implementation of the goods and services tax (GST) from 1 Apr 2015 as well as savings from the recent abolition of the petrol and diesel subsidies, ii) mega infrastructure projects such as MRT and LRT take years to complete and payments made to contractors are on a progressive basis (it is not unreasonable to assume that oil and gas prices, being cyclical in nature, will recover at some point in the near future), and iii) the proposition that the Government should even accelerate the implementation of mega projects amid an environment of low energy costs, given the resulting lower costs for inputs such as diesel, cement and steel bars.

Meanwhile, while the property sector outlook in Malaysia is challenging at present due to credit tightening, oversupply and cost pressures stemming from the GST. We believe its prospects over the long term remain positive, backed by sustained demand from new household formation (underpinned by population growth), shrinking average household size (including growing single-adult households), urbanisation, and properties as an asset class for investment purposes.

Maintain OVERWEIGHT stance on the construction sector Our bullish stance on the construction sector is reaffirmed by the Government’s commitment towards public infrastructure spending under the 11MP. We advocate owning two key big-cap construction stocks, ie Gamuda and IJM Corp.

Gamuda is the best proxy to the buoyant construction sector given its dominance in the MYR80bn Klang Valley MRT project, being the PDP for the elevated portion and the tunnelling contractor via the MMC-Gamuda JV. We are positive on Gamuda as: i) news flow on MRT2 should pick up ahead of the commencement of its physical works by mid-2016, ii) the risk of a cash call to fund the MYR27bn Penang Transport Master Plan project is now reduced, as there is a better chance that Gamuda would be able to raise the funding needs from the disposal of its 40% stake in water producer Syarikat Pengeluaran Air Sungai Selangor SB (Splash), and iii) the market should gradually shift its focus to Gamuda’s earnings recovery in FY17, from an earnings contraction in FY16. Similarly, the market should increasingly look beyond Gamuda’s property earnings risks as the property cycle bottoms out and starts to recover in the next 6-12 months.

Meanwhile, IJM Corp’s construction unit is poised for an “earnings renaissance”, backed by a record construction order backlog of MYR7bn. It is less vulnerable to policy risk (deferment of public projects on a continued slump in oil and gas prices) as more than half of its outstanding orderbook is made up of in-house jobs (WCE and Kuantan Port expansion). Prime locations of its new property launches (largely Penang Island and the Klang Valley) should buoy sales despite headwinds in the property sector.

In the small-cap space, we believe Kimlun Corp is a “must-own” stock along the value chain of the MYR80bn Klang Valley MRT project. As in the case of MRT1, we expect Kimlun Corp to supply at least half of MRT2’s requirements for segmental box girders (SBGs) and tunnelling lining segments (TLS). This is because it is one of the only two established suppliers of MRT segments in Malaysia. The other player is privately-held Eastern Pretech (M) SB. To recap, for MRT1, Kimlun Corp secured two concrete products contracts, ie TLS (MYR48.5m) and SBG (MYR223.2m). Both contracts were fully delivered in early 2015.

On the other hand, the prospects for the piling segment are strong, backed by: i) the long list of mega public infrastructure projects, and ii) a proliferation of high-rise developments amid rising land scarcity in prime locations that require extension piling. Pinta Jaya’s key strengths are: i) its full range of piling machines, tools and accessories, ii) its ability to improvise piling solutions to diverse ground conditions given its experience spanning more than two-and-a-half decade in the local piling sector, and iii) its ability to secure cash discounts for key inputs, given its strong balance sheet.