Bumpy road ahead for construction sector

Although prices for major building materials are showing signs of cooling down, this is not the light at the end of the tunnel for the Bursa Construction Index

by IFAST RESEARCH TEAM / pic TMR FILE

FOR more than two years, the Malaysian construction sector was under the radar due to the implementation of multiple pandemic-induced movement restriction orders.

Construction activities encompassing civil engineering as well as construction of residential and non-residential buildings were halted during the early stages of the Movement Control Orders. Although permission to operate was granted soon after, the challenges remained following a high number of daily Covid-19 infections at construction sites.

As a result, the Malaysian construction industry delivered an annual decline of 19.4% in 2020.

Meanwhile, the performance of the Bursa Construction Index was more forward-looking, as the recovery of construction activities was largely priced into the earlier rally the index enjoyed at the start of the year, along with the announcement of the government’s approval on MRT3 construction.

However, such gains were erased just as quickly as they began as rising building material prices amid the Russia-Ukraine war have fed into constructors’ profit margins. Soaring material costs, especially for steel (nationwide) and cement (East Malaysia) will impact margins and do not support new starts.

As a result, the Bursa Construction Index is down 3.67% as of Nov 8, 2022, despite favourable construction statistics. Regardless, it still slightly outperformed the broad market index as shown in (Chart 2).

Moving forward, we opine that the Bursa Construction Index will continue to struggle against existing and future headwinds. Below we look to outline some of our points.

False hope: Declining building material prices

The Russia/Ukraine war has sent major commodity prices skyrocketing, especially for building materials such as steel, aluminium and copper. This posed huge obstacles for construction players when bidding for infrastructure/building projects from developers, as they had to bear a certain amount of the rising costs — if not all — to stay competitive and win the bid.

Prices for major building materials have fallen off their peaks as supply chain pressure eases throughout the year. Although prices for major building materials such as steel, steel and metal section, and bricks and walls are all showing signs of cooling down, we do not think that this is the light at the end of the tunnel for the Bursa Construction Index as the underlying major concern persists. Also, these building material costs remain relatively high compared to a year ago.

As such, we think that the declining building material prices are not something to cheer for and would not be the catalyst for the Bursa Construction Index.

Labour Woes

Labour shortages have always been an issue for the Malaysian construction sector. The sector experienced labour shortages because of low interest from the locals to work in the construction industry, an unfavourable working environment, and a less desirable salary. As shown in Chart 3, the construction sector was among the Malaysian sectors with the most opening jobs, falling slightly behind manufacturing.

The Malaysian construction sector relied heavily on low-skilled foreign labour, mainly from Indonesia, Bangladesh, Vietnam, Myanmar and Nepal. The foreign workers were given low salary and when hiring foreigners’ compliance to the labour requirements are minimum. The foreign workers were normally hardworking, allowing employers to reap a hefty profit.

Ever since the outbreak of the Covid-19 pandemic, Malaysia has restricted foreign workers from entering the country, which disrupted the supply of foreign workers. This caused the delay of new projects and slow progress for existing projects. Despite the higher value of work done, only 60% of work completed more than 50% of the project completion in 3Q22, compared to 65% in the same period in 2019. Also, more projects were under 30% completion in 3Q22 compared to 3Q21 and 3Q19. According to Master Builders Association Malaysia (MBAM), the Malaysian construction industry is still facing an estimated shortage of 550,000 workers, particularly from Indonesia and Bangladesh.

Earlier this year, the Indonesian government announced plans to move the national capital from Jakarta, on the island of Java, to Nusantara, in the province of East Kalimantan in Borneo. Nusantara is expected to be home to almost two million residents by 2045 and currently, the construction for the new capital has started. It is estimated that US$33 billion (RM147.69 billion) will be spent building the new metropolis. We expect that this will lure more local and foreign labours to Indonesia, which will further worsen the issue of labour shortages in Malaysia.

Budget 2023: Two sides of same coin

Although we see the construction sector as one of the beneficiaries of Budget 2023, the lack of new large-scale contracts planned in the budget other than more clarifications from the existing ongoing mega projects, including East Coast Rail Link and MRT3, will cap the upside potential for the sector.

However, the RM95 billion development budget is still better compared to the Budget 2022 (RM75.5 billion) which the small and mid-size construction players could continue to gain some perks from the higher development spending. In addition, more uncertainties were added with the planned re-tabling of Budget 2023. When they last ruled, Pakatan Harapan (PH) had slashed the development expenditure budget.

As such, we are ‘Neutral’ on the Bursa Construction sector due to shortages of labour and elevated costs for some building materials. Despite the lack of new mega projects being announced in the budget 2023, we think that the sizable development budget for 2023 will provide much-needed support for the sector. As the road ahead for the construction sector remains challenging, we continue to prefer stocks with strong balance sheets, a consistent track record, and market leaders.

The views expressed are of the research team and do not necessarily reflect the stand of the newspaper’s owners and editorial board.