Budget 2011 – Building for the future

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Expect selected mega infrastructure project rollouts, fund-raising measures via various duty hikes in ‘sin’ sectors and gradual subsidy removals.

Construction sector is the winner, while tobacco the loser. Focusing on economic transformation programme. We expect the 2011 Budget, which will be announced on Oct 15, to feature selected implementation of the recently announced Economic Transformation Programme (ETP), fiscal prudence (flattish expenditure), higher indirect taxes particularly on six taxes, and moderate lending curbs on property (refer to RHS for more salient details).

The ETP is an aggressive long-term economic transformation programme which aims to more than double gross national income by 2020 by fostering private investment while reducing the government’s direct involvement in the economy.

The 2011 Budget expenditure is likely to be fairly flattish, featuring higher operating expenditure (higher salaries and emoluments partly offset by subsidy reductions) and lower development expenditure (according to media reports quoting the finance minister).

This is consistent with UOB Kay Hian Economic-Treasury Research’s projection for a lower deficit in 2011 of 4.5% of gross domestic produc (GDP), following a reduction to 5.3% of GDP in 2010 (2009: 7%).

The key thrust for Budget 2011 is the expected approval of the MRT project and rollout of other infrastructure projects like the LRT extension. Apart from public transportation works to be carried out in Greater KL next year, we also expect to see the starting of the Bus Rapid Transit (BRT) in Iskandar Malaysia, Integrated Transport Terminal (ITT) in Gombak, upgrading of Penang Airport, continued rural infrastructure works in East Malaysia, Double Tracking Railway (Gemas-JB) and construction of seven highways identified under the 10MP. Furthermore, we would see the government intensify the awarding of the remaining packages for the Pahang-Selangor Water Transfer project. Potential beneficiaries are Gamuda, MRCB, WCT, IJM, MRCB and Kimlun.

In line with the ETP’s drive to further promote the oil and gas (O&G) industry, further incentives or improvement in infrastructure could be introduced to promote specific O&G segments to make Malaysia a regional oil storage hub (tank farms), and we understand that the government would encourage consolidation in the fabrication segment. This could benefit petroleum tank farm ventures like Dialog and Century Logistics.

Potentially more developmental details of prized government land at Jalan Cochrane, Sungai Buloh, and Sungai Besi (air force land). While it is known that the Employees Provident Fund (EPF) and government-formed entity 1MDB are the master developers of Sungai Buloh and Sungai Besi land respectively, the government could announce the master developer of the Jalan Cochrane land, as well as the appointment of potential sub-developers for these land parcels.

Among the potential beneficiaries, we believe MRCB continues to be a front runner to develop the Cochrane land.Sin sector gets a harder knock as the government looks to raise revenue. The excise duty hike on cigarettes was raised by three three sen/stick (or 15.8%) effective Oct 1, ahead of the Budget reading, and was above market expectations of a one to two sen hike. This has prompted a hefty 70sen/pack increase in cigarette prices, which will surely induce steep consumer downtrading and earnings downgrades (our earnings forecasts for BAT were already among the lowest).

Likewise, we also expect a mild 10% excise duty hike on the brewers (after five years of reprieve) although we expect the brewers to easily pass on costs without materially affecting demand.

Casino operation the only unscathed sin sub-sector. It appears there would not be a hike on casino duty for now, despite heightened expectations following July 10’s surprise two percentage points (ppt) gaming duty hike imposed on the number forecast operators.

Bank Negara Malaysia appears to have moderated its initial indication to clamp down consumer loans, including loans extended to civil servants.

The government would most likely reduce the loan-to-value (LTV) ratio from the current 90% to 70%-80% for third and subsequent house purchases. This measure brings only a mild impact as this category of buyers are mainly cash-rich investors who can easily afford 20%-30% down payment.

We do not expect the recently talked about potential rise in real property gains tax (speculation that RPGT could be raised from the current 5% for properties sold within five years) to materialise, particularly with the general election looming.

Reduction of withholding tax for MREIT is unlikely given the government’s funding needs and MREITs withholding tax of 10% is already regionally competitive — vs 10% in Singapore and 0% in Hong Kong (although income for HREITs is taxed at 16.5% at the trustee level).

Officially introducing end-2011 target of 1,635 based on 14.5x forward PE. We conservatively apply a below post-Asia financial crisis average PE of 15x as our corporate earnings growth projections may be impacted by a falloff in external demand (2010 benefited from global inventory re-stocking and pent-up demand) and execution risks to the ETP.

The rolling out of more mega construction projects amid lower development expenditure suggests a strong reliance and ‘buy-in’ from private funding. Banks are still the most effective proxies to a rising investment cycle in Malaysia, which promotes general economic growth and hence, vibrancy in the banking sector.

Potential key Budget 2011 winners include construction and building material players like Gamuda (buy), WCT (buy), IJM (hold) for the construction sector, and MRCB for the property sector. British American Tobacco (sell) is a key loser.

Property stocks could advance should the Budget announcement confirm our view of only marginal measures against property loans, as underpinning demand is the continuation of low mortgage rates (around 4.5% presently) and overall interest rates. Our top sector pick is Mah Sing (buy).

However, there will be a temporary setback should the RPGT hike materialise, dampening market sentiment and property transactions. Potential losers are luxury high-rise developers whose buyers are mainly investors/speculators such as E&O, DNP and Bolton.

Notwithstanding the knee-jerk reactions, we remain positive on the intermediate-term property demand outlook, underpinned by the nation’s young demographics, historical low mortgage rates and stable employment outlook.
This article appeared in The Edge Financial Daily, October 6, 2010.