Malaysia – Impact Of Higher Foreign Workers’ Levy

■ The government has raised the levy for each foreign worker to RM2.5k p.a.
■ For contractors, this translates to an average 11-15% rise in foreign labour costs.
■ We estimate a 2-4% impact on sector EPS, if there is no cost pass through

New foreign worker levy structure by sector:

Malaysia foreign worker levy

New foreign workers’ levy structure

● The government has restructured the levy rate system for foreign workers into two ategories. One of the categories involves the manufacturing, construction and services sectors. In this category, each foreign worker will be charged the new rate of RM2,500/year vs. RM1,250/year previously. This new structure is effective 1 Feb 2016. The doubling of the levy is a negative surprise for most contractors.

Effective 11-15% increase in foreign labour costs; 2-4% EPS impact

● The new RM2.5k annual levy implies a monthly cost of RM208, on top of the estimated industry average salary of RM1.3k-1.9k/month of a foreign worker. This effectively works out to an 11-25% rise in foreign labour cost, which is deemed manageable. Sector wide, labour cost roughly forms 20-25% of total cost. As such, we estimate a 2-4% EPS impact for contractors under our coverage.

Actual impact on bottomline depends on several scenarios

● Guidance from contractors is that there should be an element of cost pass through, but it would depend on several factors. For contracts that are in progress/outstanding, terms could be renegotiated through additional claims with the possibility of settlement during the final certification of works. For contracts that are still in tender, pricing is typically adjusted if the bid is ongoing. In case of new tenders, new regulated cost structures such as higher levy for foreign workers will be usually priced-in.

All contractors are losers but some have better buffers

● Contractors that have jobs that are largely at the tail-end appear to be the least impacted, while contractors with relatively higher number of orders that have crossed 20-30% milestones are likely to see some margin squeeze before additional claims are recognised. Under our coverage, Gamuda could be spared in 2016 as the tender for MRT 2 is still ongoing and its single-project order book for MRT 1 is at the tail-end.Muhibbah could mitigate the higher levy with US$ priced jobs in Rapid.

Retain overweight

● The new levy structure is bad news for the sector but should be manageable over time. On the brighter side, following the announcement of the budget revision last week, most projects that are under the original list of Budget 2016 are largely intact. Investors should focus on a potential major recovery in sector newsflow from 2Q16. We believe any share price weakness from this news would be a buying opportunity.Gamuda and Muhibbah Engineering remain our top picks.

source: CIM Research – 02/01/2016