It hasn’t been an easy year for Corporate Malaysia, with political upheaval, policy changes and plenty of uncertainty hanging about. This was seen following the release of the latest round of financial results for 2018.
However, an area of respite appeared in Sarawakian companies, specifically those linked to the Pan Borneo Highway.
In its outlook on the construction sector, the research arm of Kenanga Investment Bank Bhd (Kenanga Research) projected that the mid-term focus on construction jobs could be in Sarawak.
Kenanga Research explained that the state government “is committed to implement infrastructure projects that improves the connectivity in the state and improves the welfare of people in Sarawak which we might see contract flows from Sarawak to pick up in 2Q19 onwards”.
“As for Peninsular side, we would expect potential awards news flow of retendered projects in the second half of 2019 (2H19).”
This is compared to the nation’s construction sector overall, as the segment’s fourth quarter of financial year 2018 (4QFY18) results came in mixed with weaker sales and lower profit margins being the main drags during the period.
According to the research arm of Public Investment Bank Bhd (PublicInvest Research), the construction sector ended the 4Q of 2018 (4Q18) reporting periof with uninspiring numbers to be expected ahead.
“Overall, we found that the key concern in most construction companies’ earnings outlooks are profit margins, case in point Hock Seng Lee Bhd (HSL) which reported strong top line numbers but weak at the bottom line. Profit margins compressed due to change of product mix as more low-margin projects are being executed currently.”
On the other hand, Affin Hwang Investment Bank Bhd (AffinHwang Capital) noted that the construction earnings downgrade cycle since 2017 seems to be bottoming and market expectations are aligned.
“Aggregate core net profit for the construction sector saw a 37.1 per cent year on year (y-o-y) plunge in 4Q18 due to the ongoing review of projects by the government to reduce costs,” AffinHwang Capital said.
“Progress billings for major infrastructure projects such as LRT3 and Pan Borneo Highway Sarawak were slow.”
“Construction companies with property projects generally saw weaker sales and lower profit margins in 4Q18 due to the sustained weak property market conditions.”
It added that several companies recognised impairments for company acquisitions and property stocks that led to depressed earnings or losses in 4Q18.
The Borneo Post reported updates in February on the Pan Borneo Highway, as Works Minister Baru Bian indicated that the construction of the second phase, stretching from Miri to Lawas, could start as soon as next year.
Works Minister Baru Bian had said the construction of this stretch, described as the missing link for the highway project, will not be under the coming 12th Malaysia Plan (12 MP).
He added that the ministry was still assessing the costs and its details would be revealed when the time comes.
“As far as we are concerned, the second phase is part of the first phase (for this project).
“Meaning to say, that one (the second phase) can commence as soon as possible (once we have the budget).
“I will be looking at the budget estimation.
“To me, this is something which needs to be expedited. I am looking at even probably starting it next year if it is possible,” he said.
The first phase of Pan Borneo Highway, from Sematan to Miri, is in various stages of construction.
Meanwhile, the state Ministry of Infrastructure Development and Transportation revealed in early January that the construction of the Sarawak stretch of Pan Borneo Highway from Telok Melano to Sematan stretch (32.77 kilometres) had achieved practical completion by the contractor.
As for the second phase, the proposed route is to start from Miri to Limbang and then Lawas, without passing through Brunei.
The length of the missing stretch is reportedly about 250km and expected to cost about RM3.5 billion to construct.
With this, BizHive Weekly looks at three Sarawakian companies and how they have gained from the Pan Borneo Highway project – and how they still will.
Good year for CMS
For FY18, Cahaya Mata Sarawak Bhd (CMS) reported a total revenue of RM1.71 billion for FY18, an increase by nine per cent, in comparison to the preceding year’s (FY17) revenue of RM1.58 billion.
On the group’s profit after tax and non-controlling interests (PATNCI), it amounted to RM265.74 million, 28 per cent higher than FY17’s PATNCI of RM208.03 million.
In its 4QFY18 results review, the research arm of MIDF Amanah Investment Bank Bhd (MIDF Research) observed that CMS’ fiscal result was broadly positive as the group’s 12MFY18 profit after tax and minority interest (PATAMI) recorded growth of 27.7 per cent to RM265.7 million.
“The cumulative earnings came within expectations, accounting for 103.1 per cent and 98.8 per cent of ours and consensus’ yearly estimates,” MIDF Research said.
The research arm went on to note that CMS’ 12MFY18 income was largely underpinned by construction or road division, growing by 20.8 per cent y-o-y to RM554.2 million.
“While its profit before tax (PBT) growth was negligible at 0.2 per cent y-o-y, the quantum was steady at RM90.4 million (versus RM90.2 million in the same period last year).
“We understand that strong income was largely recognised from the on-going construction of Pan Borneo Highway, the Miri-Marudi road rehabilitation and the Sarawak Museum projects.”
As for CMS cement and construction materials division, despite recording a healthy growth in revenue, MIDF Research took caution of the lower margins realised at PBT.
“This was mostly apparent in the cement division, which accounted for 33 per cent of the group’s total income in FY18.
“Whilst its revenue increased by seven per cent y-o-y, PBT however dropped 11 per cent y-o-y to RM90.1 million.
“The decline stemmed from repair costs at its clinker plant and the increase in imported clinker price due to supply shortages globally.”
Moving forward, MIDF Research expected margin could trend better as the research arm made allowance for possible reduction in cost/unit output.
“We think the approach is feasible, as management closely monitor and optimise its plant performance. We learned that management has set a sales target of 1.58 million metric tonnes (MT) in FY19 for the cement division.”
Growth in rural areas
In a results preview report on CMS, RHB Research Institute Sdn Bhd (RHB Research) projected that there is potential growth in cement demand from rural-focused projects in Sarawak.
The research house had noted that management expects demand for cement to surge in late 2019 to 2020 from the construction of the Baleh Dam and Pan Borneo Highway Sarawak projects (current progress at circa 35 per cent).
“We also see potential growth in cement demand from rural-focused projects to be initiated in Sarawak,” it said.
“The State Government has announced a record budget of RM9 billion to finance various programmes and projects under the 11th Malaysia Plan, including socio-economic and rural transformation initiatives.”
In CMS’ media release on its latest financial results, group chief executive officer – Corporate Dato Isaac Lugun expect to see improved performance of CMS’ traditional core businesses of Cement, Construction Materials and Trading and Construction and Road Maintenance to be primarily driven by the Pan Borneo Highway project.
“It will also be supported by the State government’s increased spending on infrastructure, as seen in its 2019 record budget of RM9.07 billion for development which in part will fund the implementation of major infrastructure projects including the Coastal Road, Second Link Road, Water Grid and Electricity projects.
“This ensures that the State will be a pocket of increased construction activity for next few years unlike in Peninsular Malaysia where the research houses have lowered their outlook for the construction sector.”
“We are confident that CMS will continue to maintain its strong growth potential and will remain resilient in spite of expected headwinds. With its healthy balance sheet and diverse portfolio of businesses, the group is well positioned to benefit in all key growth areas in Sarawak.
“We expect this to be through: OM Materials (Sarawak) Sdn Bhd in the Sarawak Corridor for Renewable Energy (SCORE) initiative, SACOFA Sdn Bhd in the State’s push to fully embrace the digital economy and PPES Works (Sarawak) Sdn Bhd and our other construction materials supply companies in the roll-out of the Pan Borneo Highway project and other major infrastructure projects recently announced by the State government.”
All in, RHB Research trimmed its FY18-20F net profit by five-six per cent as the research house pared down the earnings growth outlook of CMS’ cement division.
“That said, CMS is still our top sector pick, as it is set to benefit from Pan Borneo Highway Sarawak projects and the state’s RM9 billion development budget.”
Long term narrative in Sarawak
As for MIDF Research, the research arm was encouraged to see that the group’s operations are progressing well, denoting positive tone on production demand and construction progress.
“Moving forward, we see the future development of Sarawak will provide strong narrative to the long-term sustainability of CMS, which has significant presence in the state,” the research arm said.
“Accordingly, we believe the state’s development plan funded by RM9.1 billion budget allocations will be able to fuel further optimism on the state’s construction outlook.”
Following CMS recent package award of the Sarawak Coastal Road, analysts were generally positive on this development given that it also signaled the Sarawak State’s commitment to implement the project.
“The awarding of this package signals the Sarawak State’s commitment for the Sarawak Coastal Road to take off. With a slew of bridges expected to feature in both the Sarawak Coastal Road and Second Link Road, CMS will also benefit as the sole cement and major building materials supplier within the state,” the research arm of Maybank Investment Bank Bhd (Maybank IB Research) said.
Meanwhile, MIDF Research noted that the pending roll-out of the state infrastructure projects will stimulate further optimism on the stock, while enabling CMS to improve the group’s core earnings.
“We opine CMS is in the position to benefit given its extensive value chain and strong presence advantage.
“In the meantime, we opine further progress of Pan Borneo Highway will benefit CMS in the form of sustainable earnings accretion in the near term.”
KKB: Above and beyond
KKB’s earnings were beyond analysts’ expectations, with the group’s net profits beating estimates on the back of an overall better performance from its engineering sector.
MIDF Research saw that KKB’s mettle was shown from the stark improvement in financial results as well as the group’s ability and competency to secure new contracts.
KKB’s 12MFY18 earnings came in ahead of the research arm’s and consensus’ expectations at 126 per cent and 118.8 per cent, respectively.
According to KKB in the group’s latest financial results filing on Bursa Malaysia, profit attributable to ordinary equity holders of the parent amounted to RM17.64 million in the year ended December 31, 2018, a drastic increase from RM1.61 million in the corresponding period of the previous year.
KKB’s civil construction division showed a 50 per cent growth in revenue for the fourth quarter of 2018 (4Q18), recording a revenue of RM66.9 million, compared to RM44.6 million in 4Q17.
The group attributed the increase to “higher progressive claims from its main project – the development and upgrading of the Proposed Pan Borneo Highway in the State of Sarawak (Phase 1 Works Package Contract – WPC-09) undertaken by the subsidiary company i.e KKBWCT Joint Venture Sdn Bhd”.
MIDF Research noted that in 4QFY18, the group’s operating revenue was significantly higher compared to last year, rising by 103.1 per cent y-o-y to RM142.5 million.
“Revenue contributions were largely driven by engineering and construction sector, which made up 91 per cent of the quarterly aggregate.
“The segment was supported by Pan Borneo Highway package, which we expect to continue this year,” the research arm said.
MIDF Research also highlighted that KKB’s expertise lies in the steel fabrication and piping segments, which have helped to chart meaningful milestones for the group thus far.
Looking ahead, the research arm believed that the group’s track record and niche expertise will bode well with the prospect of Sarawak development.
“We think that KKB is likely to be the beneficiary of state water projects, proven by the recent wins.
“We recall that Sarawak has allocated approximately RM2.8 billion to fund a total of 247 water and water-related projects for implementation within the next two years.
“Positively, we understand that the water-grid project has commenced tender rounds for phase 1, which denotes positive tone on the likelihood of more new roll-outs.
“On that note, we think KKB is poised to benefit from works which involve the supply of steel water pipes and structural steels.”
Earnings miss for HSL, but good orderbook ahead
It was a tough year for HSL as its FY18 earnings missed analysts expectations, caused by factors such as higher-than-expected depreciation expenses, slower construction work progress at some major projects and lower-than-expected margins, among others.
The group’s profit and total comprehensive income attributable to owners of the company for the year ended December 31, 2018 amounted to RM53.75 million, up from RM47.61 million the year earlier.
According to the research arm of Hong Leong Investment Bank Bhd (HLIB Research), HSL’s FY18 core earnings RM53.8 million accounted for 89 per cent of its full year forecast (consensus: 92 per cent) which was below expectations.
“The deviation of results is mainly due to higher than expected depreciation expenses incurred,” it said.
HSL’s FY18 net profit also missed AmInvestment Bank Bhd’s (AmInvestment Bank) forecast and consensus estimates by seven per cent and eight per cent respectively.
“We believe the variance against our forecast came largely from slower construction work progress at major projects coupled with lower margins realised,” the research firm said.
The group’s FY18 net profit came in below expectations of the research arm of Public Investment Bank Bhd’s (PublicInvest Research) and consensus expectations at 94.1 per cent and 91.9 per cent of earnings estimates, respectively.
PublicInvest Research said the discrepancy was mainly due to higher costs recognised during the period with gross profit (GP) margin dropping by 3.9 per cent from 18.7 per cent last year mainly due change of product mix.
Rosy orderbook outlook
Despite the group’s disappointing results, HLIB Research viewed that HSL’s orderbook level is still healthy and has thus retained its FY19 orderbook replenishment rate.
“HSL’s orderbook of RM2.2 billion remains at a healthy level. This translates to a strong cover of 4.2-fold on FY18 construction revenue. We maintain our FY19 orderbook replenishment rate and it has secured RM54 million worth of contracts year to date (YTD).
“We deem the replenishment rate as conservative as we expect jobs start rolling out from Sarawak this year as projects such as Sarawak Coastal Road and Trunk Road as well as water works are mostly in tendering stage after pre-qualification.”
“We understand that two HSL’s mega projects namely Pan Borneo Highway (35 per cent completion) and Miri wastewater job (40 per cent completion) are in advanced stages with high construction progress billing and hence we expect earnings momentum to continue accelerate going forward.”
PublicInvest Research also viewed HSL’s outstanding orderbook as healthy, noting that as at December 31, 2018, the group had a balance orderbook of RM2.2 billion translating to circa 4.4-fold of FY18 construction revenue.
AmInvestment Bank noted that at present, HSL’s outstanding construction order book of RM2.2 billion comprised of largely remaining works for the RM1.2 billion work package for the Pan Borneo Highway (total value for the work package is RM1.7 billion, HSL has a 70 per cent share), the RM333 million Miri Wastewater Management System and the RM563 million Kuching City Central Wastewater Management System (Phase 2) (total contract value is RM750 million, HSL has a 75 per cent share).
“In terms of job wins, our forecasts assume RM250 million annually in FY19-21F.”
More contracts for the win
HSL’s filing on Bursa Malaysia last month highlighted that the group received two letters of acceptance from Sarawak Energy Bhd for a project in Mukah known as “2X312MW Balingian Coal-Fired Power Plant Project, Package C05A – Earth Works and Common Facilities and Package C05C – Operator’s Residence” with a combined value of RM54.3 million, through an open tender exercise.
On the property division, HSL managing director Datuk Paul Yu revealed that the group has RM240 million worth of property development projects ongoing and will launch approximately RM160 million worth of new projects in 2019.
“As for profit margins, we see it remaining at current levels, ranging from 13.7 per cent to 14.5 per cent at gross level as bulk of its balance orderbook is from low-margin infrastructure projects which carry a margin of about 10 per cent to 12 per cent,” PublicInvest Research said.
Overall, AmInvestment Bank remained cautious on HSL due to the cutback in public infrastructure spending nationwide, including East Malaysia, as the government adheres to greater fiscal prudence.
“With the altered political landscape following the 14th general election in 2018 (coupled with the Sarawak state election by September 2021), we could potentially see a greater participation of Peninsular boys in the construction market in Sarawak (especially for projects financed by federal funds), resulting in increased competition and hence reduced margins.
“However, this is mitigated by Sarawak being HSL’s home turf and its niche strength in marine works or land reclamation.”
On the group’s participation in future infrastructure projects in the state, Yu noted that Sarawak is tendering out a number of substantial infrastructure projects such as the Coastal Road and Trunk Road project packages and that HSL “shall be capitalising on such upcoming opportunities as they suit our capabilities”.