Time for govt to tighten belt

by **Cals** Thu 03 Oct 2013, 09:50

Time for govt to tighten belt
Business & Markets 2013
Written by Alliance IB Research
Thursday, 03 October 2013 09:36

CONSTRUCTION [] sector
Downgrade to neutral (from overweight): In July, Fitch Ratings downgraded its outlook on Malaysia from “stable” to “negative”, citing weak prospects for budgetary reforms and rising contingent liabilities.

The downgrade serves as a strong reminder for the government to swiftly address its fiscal position. Fiscal tightening has already begun with the recent fuel subsidy cut.

In view of the government tightening its coffers, we believe it is inevitable that certain projects will be scaled back or scrapped as the government takes on a more prudent spending stance.

Prime Minister Datuk Seri Najib Razak has said that priority will be given to projects with low import content and high multiplier effects. High import content projects will, meanwhile, be “sequenced”, he added.

Last year saw a record number of contract awards, at RM27.9 billion, thanks largely to the Klang Valley mass rapid transit (MRT) project.

We believe this is unsustainable year after year and estimate a RM13 billion job flow for 2013.

Fiscal tightening will also have an impact on private finance initiative (PFI) projects as we believe the government will cut down on guaranteeing debts of concessionaires and extending soft loans, both of which are crucial in ensuring project viability.

We do not expect private sector contracts to make up for the scale back in government jobs. In the last four years, the private sector only contributed 25.5% to overall contracts.

Unlike previous budget announcements, which had unveiled a list of grandiose projects, we expect a muted tone this time around when Budget 2014 is presented as fiscal tightening comes into play.

Budget 2014 could potentially see a 6.9% year-on-year (y-o-y) decline in development expenditure. This does not augur well for the construction sector given the strong 85% correlation between development expenditure and nominal sector output.

Projects that we believe are likely to be “sequenced” include the Tun Razak Exchange (due to oversupply of office space), Rapid or Refinery and Petrochemicals Integrated Development (due to foreign investor pullouts), Kuala Lumpur-Singapore high-speed rail (non-consensus government-to-government agreement) and light rail transit Line 3 (delay in completion of existing extension project).

While we take comfort in the news that MRT Line 2 and 3 will proceed, we caution that its first half of 2016 timeline could be a moving target if the Cabinet’s approval is not procured by year-end.

Other projects that should proceed include the Langat 2 water treatment plant and urban highways such as the Damansara-Shah Alam Elevated Expressway, Sungei Besi-Ulu Klang Elevated Expressway and Kinrara-Damansara Expressway.

Given the inevitable tapering of contract flows due to fiscal tightening, we downgrade our rating on construction from “overweight” to “neutral”.

Downside risk is mitigated by the fact that most contractors are sitting on healthy order book levels, which should help sustain earnings during this “dry spell”.

Our top pick is GAMUDA BHD [] for its exposure to the MRT project and special dividends from the impending sale of its stake in SPLASH Holdings Bhd. We also like AHMAD ZAKI RESOURCES BHD [], which should benefit from projects that have “carved out” portions for bumiputera contractors. — Alliance IB Research, Oct 2

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This article first appeared in The Edge Financial Daily, on October 03, 2013.