Upgrading construction sector to NEUTRAL. We are raising our call on the construction sector to NEUTRAL from
UNDERWEIGHT. Newsflow momentum on the sector should gain traction in the coming months. We are not expecting
much kickers from the upcoming “Mini Budget” stimulus - on March 10 - believed to be in the region of RM10bil-Rm15bil,
given that it would most-likely be SME-centric, in our view. Also, we do not expect new or fresh high-impact contracts
to be announced.
Our sector upgrade is premised largely on the resumption of previously stalled projects under the 9th Malaysia Plan
(9MP) post the leadership transition in March. This will include the RM9bil Pahang-Selangor inter-state raw water transfer
(both Pahang and Selangor portions), RM35bil public transportation upgrading program, Bakun Hydroelectric project
(RM14bil) and West Coast Expressway (RM3bil). Meanwhile, we have seen a re-acceleration of works for the 2nd
Penang Bridge, Ipoh-Padang Besar double tracking project, smaller parcels of new contracts to link the various Klang
Valley highways as well as select infrastructure projects in Sabah and Sarawak. Moreover, the existing orderbook levels
of construction companies under our coverage remains healthy - and should sustain construction earnings over the next
two to three years.
l WCT our top sector pick. Within the sector, we have upgraded WCT Bhd (WCT) to a BUY from SELL with a higher Sum-
Of-Parts (SOP) derived fair value of RM1.89/share. We believe uncertainties surrounding the cancelled Meydan
racecourse project has been priced-in at current levels. Moreover, the market is ignoring WCT’s deep values. Assuming
zero contributions from its construction/other divisions, WCT’s base valuation of RM1.60/share is backed by its property
assets - 60% of this total comprises of strategic property investments with recurring income streams (e.g. the Aeon Mall
in Klang). More importantly, there is significant scope for PE expansion on contract deliverance.
l We have taken our recommendations on Gamuda and IJM Corp Bhd (IJM) one-notch above to HOLD with higher SOPderived
fair values of RM2.06/share and RM3.88/share respectively. In our view, both companies should be among the
key beneficiaries of any pump-priming initiatives by the Federal Government. This is due to their select strengths and
solid track-record in undertaking several cornerstone projects under the 9MP.
l We reiterate our HOLD rating on Zelan Bhd (Zelan) with an unchanged fair value of RM0.95/share. Due to unresolved
stewardship issues, we project core net profit to contract by 9% in FY10F to RM94mil from a 19% growth in FY09F amid
stagnating order flows. We have assumed that Zelan will not clinch any new orders in FY09F with a FY10F’s of RM250mil
versus RM2.6bil secured for the 14-months ended March 2008. Hock Seng Lee Bhd (HSL) remains a HOLD with an
unchanged fair value of RM0.61/share. We are only projecting HSL to achieve modest earnings growth of 10% for FY09F
due to muted new order flows and slower work progress at some of its flood-afflicted projects in Sarawak.
l Select 9MP projects are taking-off. From our recent company visits, we note that there has been quiet progress made
at some of the existing high-impact infrastructure jobs. Initial earthworks for the 2nd Penang Bridge project have started,
while tenders for the Klang Valley LRT expansions could be out as early as 2Q09. Meanwhile, we see the Penang state
government’s lifting of a stop-work order issued to the MMC-Gamuda JV as an early step towards resolving the dispute
on land acquisition for the Penang stretch of the double tracking project after the JV paid a RM4mil planning fee. Select
companies are also re-juggling their capacities in anticipation of new contracts with the imminent award of the tunnelling
package under the Pahang-Selangor inter-state raw water transfer project.
l Margin pressures have somewhat eased, but near-term earnings recovery remains muted. Our channel checks
with various contractors reveal that construction margins are likely to bottom-out during the current and possibly next
reporting season once adjustments for inventory write-downs are provided for. Domestic prices for steel bars - accounting
between 15% to 30% of construction cost - have fallen by a sharp 45% to RM2,000/tonne from its peak of RM4,100/tonne
in June 2008. While cost pressures have somewhat eased, we believe the restoration of construction margins and
subsequent recovery in earnings are likely to remain muted in the near-term. This would be more so for overseas projects,
where the combination of intensifying competition and sticky raw material prices (e.g. bitumen) may lead to thinner
margins for new contracts. - See Page 2

l Lower foreign shareholding. The level of foreign shareholding among construction stocks have dropped quite
substantially over the last three months. This should help lend further support to the share prices of construction stocks,
as the risk of a share price-overhang associated with foreign selling diminishes. For instance, IJM’s foreign
shareholding has dropped to 30% presently from its peak of 65% during the mid-2007s.
l The funding conundrum. In our opinion, there are lingering uncertainties on how the Federal Government would
efficiently fund the roll-out of 9MP projects. This is due to a ballooning fiscal deficit - currently at 4.8% - but may be
higher given the risk of falling fiscal revenues. As it is, net issuances of Malaysian Government Securities (MGS)
totalling RM37bil this year is already at a multi-year high. We think the Federal Government may issue Government-
Guaranteed (GG) bonds to help fund these projects. There are admittedly some concerns, given the proliferation of
fund-raising in the market by both the government and corporates. We need to see the tough funding environment
abate before we upgrade the sector further to an OVERWEIGHT.
l Order visibility for overseas projects remain opaque. On the overseas front, orderbook visibility is still muted as
traditional construction markets (e.g. Middle East, India) are facing tough times amid intensifying competition. There,
however, may be some surprises coming from select construction companies with good track-records such as WCT.
l Land acquisition remains a thorny issue. We understand that there are still some unresolved issues surrounding
land acquisitions along the Penang stretch of the Ipoh-Padang Besar Double Tracking project. To date, only 65% of
the land has been handed-over compared to the earlier target of 95%. This may have significant implications on the
Pahang-Selangor inter-state raw water project, given that the status of the Selangor portion (Langat 2) remains unclear
even with the imminent award of the tunnelling package.
l Big-ticket projects may be broken up into multiple smaller packages. Due to intense political lobbying, there has
been rising concerns that select big-ticket projects in the pipeline may be broken up into multiple smaller portions (e.g.
30% or RM3.7bil worth of contracts for the Ipoh-Padang Besar Double Tracking project were awarded to Bumiputra
contractors under 338 work packages). Apart from execution hiccups, the breaking-up of contracts into smaller
packages will undoubtedly translate into a reduced share for the larger construction companies.