Highlights

• Spending still robust. Development expenditure (DE) for 2016 has been originally earmarked at RM50bn (+22.6% YoY). While budget recalibration in January had scaled back DE by RM5bn, we understand that the cut is mainly for nonphysical projects (i.e. R&D) instead of infra projects. With the recovery of oil prices to US$45-50/bbl, fiscal position has improved, enabling the government to unwind some its spending cuts. Long term sector prospects are supported by the RM260bn allocation under the 11MP (+13% vs 10MP).

• Outperformance persists. Real construction growth has outperformed overall GDP since 1Q12. Our economics team expects the outperformance of construction to persist for 2016 as well at 10.2% against softer GDP growth of 4.2%.

• Record contract flows. In 1H16, domestic contract awards to listed contractors totalled RM38bn, making it a record year despite being only at the hal fway mark. Putting it into perspective, the 1H16 sum has already surpassed last year’s RM22bn and the previous high of RM28bn in 2012.

• What’s in stalled for 2H? We expect the following contracts to be rolled out in 2H16: (i ) 6 viaduct packages for the MRT2 (RM7-8bn), (ii) 8 packages of the Pan Borneo Sarawak (RM10-12bn), (iii) urban highways such as the DASH (RM4bn) and SUKE (RM4bn) and (iv) LRT3 (RM9bn).

• Catalytic developments. Catalytic developments within the Klang V alley such as Tun Razak Exchange, K wasa D’sara, Bukit Bintang City Centre, Cyberjaya City Cent re and Bandar Malaysia will also provide contractors with another avenue of job flows. Collectively, these 5 catalytic developments have a GDV in excess of RM200bn. Despite the softening property market, we reckon that risks of delays for these developments are low given that they are all backed by Government owned entities.

Risks

• The key risk is a softening domestic property market which may see slower job flows from private sector developers.

Rating / Valuation

• OVERWEIGHT

• Our OVERWEIGHT rating on the construction sector has thus far proven correct with the KLCON outperforming the KLCI by +5.4% YTD (absolute: +3.4%).

• With 2016 being a record year for contract flows, we retain our OVERWEIGHT rating on construction. Expect cont ract flows to remain robust for 2H16.

Top Picks

• For the large cap contractors, we highlight Gamuda (BUY, TP: RM5.65) as our top pick given its expected earnings resurgence from the rollout of the MRT2. We also like WCT (BUY, TP: RM2.12) as we believe it is set to witness a reversal of fortunes. The impending listing of its construction arm and REIT are tell-tale signs that a positive earnings momentum is forthcoming.

• For the small caps, we like Mitrajaya (BUY; TP: RM1.88) which should see a revival of job wins this year, coupled with an 11% 3-year earnings CAGR at undemanding valuations.

Source: Hong Leong Investment Bank Research - 22 Jul 2016