Highlights

Construction outperforms… The KLCON Index is up 5.7% YTD vis-à-vis the KLCI Index which posted flat performance. This is unlike the construction sector which has been underperforming the KLCI for two years in a row since 2011. Moreover, the natural reaction upon the dissolution of parliament would be for investors to adopt a risk adverse approach and avoid the sector as occurred prior to build-up of 2008’s General Election.

Election fatigue?… We believe that the election risks have been largely priced-in after the sector has been largely sidelined for more than 2 years and underwent few bouts of selldowns (please refer to our reports “Election risks largely priced in” dated 13 Sep-12 and “Election kneejerk” dated 22 Jan-13). Hence, we are seeing returning interests into the sector as funds position themselves for post-election strategy. We also agree that the recent foreign inflows have also helped supported the construction sector.

Improved fundamentals… More importantly, the construction sector has adequate fundamentals to support its share price. Most construction players have successfully replenished their outstanding order book with an average run rate of 2.2x (see Figure #3) which provides earnings visibility over the next 2-3 years. Post-election, there will be additional projects to be won and this will further bolster the sector’s fundamentals.

Where is the next catalyst?… Our Top Picks for the sector was revolved around the liquid large cap counters and most of the share prices of these counters have reached close to our Target Prices. We believe that further upside is unlikely due to the lack of major catalysts which will most likely occur after the election.

Going small… Hence, we believe that interest is likely to flow towards the laggards and mid/small cap stocks which are still trading at palatable valuations.

Catalysts

• Upgrades: Higher than expected project values; faster than expected implementation of projects; and return of risk appetite.
• Downgrades: Delays in rolling-out new projects; and changes in ruling Government.

Risks

• Execution risk; regulatory and political risk; rising raw material prices; and unexpected downturn in the construction and property sector. Rating/ Valuation OVERWEIGHT
• We are maintaining our OVERWEIGHT stance in the sector but with emphasis on the mid/small cap construction companies given the palatable valuations compared to the big caps.

Top Picks

• Kimlun (BUY; TP: RM2.18)
• HSL (BUY; TP: RM2.09)
• Mudajaya (BUY; TP: RM3.53) – Year end boost from power projects and India power plant
• MRCB (BUY; TP: RM2.15) – Opportunistic election play

Source: Hong Leong Investment Bank Research - 10 Apr 2013