As construction recovery takes hold, building materials plays see different prospects

The recovery of the local construction sector, following major stoppages during the pandemic, has helped lift the earnings of not just contractors, but also upstream companies, like those who supply building materials.

Two pure-play building materials stocks, BRC Asia and Pan-United Corp, have already gained 11.04% and 25% year to date respectively. Analysts covering these stocks have kept their upbeat view, suggesting further upside.

BRC Asia, which provides steel reinforcement solutions for construction projects, reported on Aug 2 that earnings for its 3QFY2022 ended June had doubled from $10.2 million to $20.4 million. Revenue for the same period was up 52% y-o-y to $515 million, as the company enjoyed gains in both volume and prices.

In their Aug 4 note, CGS-CIMB analysts Ong Khang Chuen and Kenneth Tan maintain their “buy” call and target price of $2.50 on BRC Asia, representing a potential upside of 31.6% from the Aug 24 closing price of $1.71.

They note that BRC Asia was able to maintain its profitability in the face of rising costs. Its net margins improved by 1 percentage point to 4% y-o-y for 3QFY2022, which they interpret as “BRC’s capability to pass on some of the higher costs”.

In its earnings commentary, BRC Asia also maintains its upbeat take on the wider construction environment, citing official estimates that the growth of the local construction sector is accelerating.

In 2Q2022, the sector grew 3.8%, up from 1.8% recorded in the preceding first quarter. This was in part due to the relaxation of border restrictions on the inflow of migrant workers.

However, there is a potential risk in the form of a higher number of workplace accidents, leading to safety time-outs and work stoppages with each fatality. In the first six months of 2022, there were 28 fatalities, up from 17 deaths during the same period pre-Covid in 2019. A higher number of dengue cases has also led to additional work stoppages. Ong and Tan think that these are “transient issues that should be alleviated in the upcoming quarters”, adding that they continue to expect a further recovery in construction activities in the second half of 2022.

BRC Asia, to them, is trading at an “attractive” valuation of just 6x FY2023 estimated earnings. They also believe that with the company’s strong free cash flow generation, it can potentially offer a dividend yield of 11%, assuming a 60% dividend payout ratio.

SAC Capital’s Peggy Mak, in her Aug 19 note, rates BRC Asia as “hold” with a target price of $1.92. She flags that en-bloc transactions have gained pace, which would spur the overall level of construction activities, including public housing.

However, Mak cautions about possible near-term risk with higher interest rates and potential property cooling measures dampening the buying fever, hence lowering developers’ appetite for new projects and, by extension, construction demand.

Furthermore, rebar prices from China have corrected by 24% from the recent peak of RMB5,258 ($1,073) per ton in May this year, due to recessionary fears and a slowing Chinese economy.

Nonetheless, she believes that steel prices will recover because of the current low inventory, the shuttering of China’s production capacity due to power rationing, and the higher energy prices that lift the cost of production.

Rising prices, surging costs

Besides steel bars, concrete is also a ubiquitous material at any construction site, and Pan-United Corp, which supplies ready-mix concrete (RMC) to sites, has also seen similar fortunes to BRC Asia.

On Aug 3, Pan-United reported earnings of $13 million for its 1HFY2022 ended June 30, which is almost double compared to the same period last year. Revenue was up 22% y-o-y to $338 million, thanks to higher volumes and better selling prices. For example, the average selling prices of RMC in June was up 24% y-o-y.

CGS-CIMB’s Ong and Tan think that near-term average selling prices (ASPs) are likely to remain elevated on the back of rising costs and rising operating expenses will continue to be a concern. They note that Pan-United recorded staff costs that were up 25% y-o-y and utilities up 20% y-o-y. Nevertheless, that the higher costs “remained well-handled”, and that the company’s ongoing investments in creating better-value RMC has helped mitigate rising costs.

The analysts believe that the same workplace safety time-outs will weigh on Pan United’s RMC demand the way they did for BRC Asia’s steel. Nevertheless, overall sector tailwinds are “still intact” in 2HFY2022 with easing labour shortages and projects resuming.

BRC Asia says in its earnings commentary that construction order books island-wide have remained “robust” due to strong demand for public housing and infrastructure projects. For example, the HDB remains on track to launch up to 23,000 new flats in 2022, with 3,900 and 4,600 flats launched in February and May respectively, and upcoming launches of 4,900 and 9,500 flats in August and November respectively. “This bodes well for the demand for reinforcing steel and BRC, which are an integral part of the local construction supply chain,” the company notes.

Another local listed company with exposure to the building materials sector is Hong Leong Asia, part of the Hong Leong Group. Besides its own cement businesses in Malaysia via its stake in Tasek Corp, and Singapore Cement Manufacturing Co here, it holds a 44.7% stake in New York-listed China Yuchai International, which builds heavy machinery and engines out of its base in Guangxi, China.

Closer to home, Hong Leong Asia last year raised its stake in BRC Asia from 3.6% to around 20% after investing $68.1 million via a placement of new shares at $1.48 each.

On Aug 11, Hong Leong Asia reported that revenue for its building materials segment was up 26.5% y-o-y to $282 million. Profit after tax for the segment more than doubled y-o-y to $28.7 million from $10.7 million. These results include Hong Leong Asia’s 20% stake in BRC Asia.

Hong Leong says that this was due to construction activities in Singapore and Malaysia continuing to recover and driving demand for concrete and related products, although it does warn that in Malaysia, the construction-related segment remains challenging given higher input costs, a shortage of labour and tighter credit conditions.

Overall, Hong Leong Asia reported earnings of $42.6 million for its 1HFY2022, up 4.5% y-o-y. Revenue was down 26.1% y-o-y to $2.1 billion, led by the drop in its diesel engine business in China, which suffered from the pandemic-related curbs. Year to date, Hong Leong Asia shares are down 11.76% to close at 75 cents on Aug 24.

In their Aug 23 note, CGS-CIMB analysts Ong and Tan, citing expectations of higher earnings for 2HFY2022 ending December, have kept their “add” call on Hong Leong Asia, raising their target price slightly from $1 to $1.05. “Potential catalysts include faster recovery in Singapore’s construction sector or Chinese government’s stimulus measures catalysing diesel engine sales,” they note.

GKE limits RMC exposure

However, not all Singapore-listed building materials plays are on the same track. GKE Corp for example, owns warehouses in Singapore, which are enjoying healthy demand from clients stocking up amid the pandemic. On the other hand, its other main business, in RMC, cannot be said to have done as well.

GKE’s RMC plants are in Wuzhou and Cenxi cities in China, and in a previous interview with The Edge Singapore in 2021, GKE’s head of human resources, procurement and administration Chen Jiang Nan explained that due to the nature of RMC, the China operations are extremely local.

While this means GKE’s RMC business is mostly immune from international supply chain troubles and the US-China trade war, the converse is true when China’s domestic economic growth slows following lockdown restrictions across the country to deal with the pandemic.

For its FY2022 results ended May, GKE’s RMC segment suffered a 43.4% y-o-y drop in revenue to $29.9 million from $52.8 million in FY2021. The company says that this was due to “unexpected turmoil” in China’s real estate sector, as well as stringent precautionary measures to comply with China’s zero-Covid policy.

Responding to queries from The Edge Singapore, GKE CEO Neo Cheow Hui explains that the spillover effect from over-leveraged property developers in China’s real estate sector, particularly in the residential segment, has affected the construction sector which supports property development projects.

He maintains that demand for RMC remains but GKE prefers to manage its credit risk exposure by focusing on selling to infrastructure projects rather than to property developers.

Furthermore, given the recent surge in Covid cases in China, precautionary measures had to be implemented, including constant disinfection and regular testing of employees, affecting operations, Neo adds.

“Our RMC facilities, as well as the construction waste recycling plants, remain operational, but the slowdown in construction activities and fears of lockdowns are real concerns in the near term,” he says.

Despite these short-term pressures, Neo is positive about the long-term prospects for its RMC business. As the plants are located in less developed cities, he notes that there are more opportunities to support local urbanisation and infrastructure projects.

GKE shares closed at 10.2 cents on Aug 24, down 21.54% year to date, valuing the company at $83.5 million.