Highlights

• Higher proportion of those below. For the recent 2Q17 results season, 6 out of the 13 contractors under our coverage (46%) reported core earnings that were below expectations, 4 (31%) were within and 3 (23%) were above. Consensus estimates are only available for 9 of our 13 covered construction stocks, of which, 6 (67%) were below and 3 (33%) were above.

• Disappointments due to topline... Of the 6 results disappointments, half were revenue driven. Kimlun had a timing gap for its manufacturing deliveries between its completed Singapore jobs and commencement of MRT2. On the other hand, HSL experienced delays in kicking off its Kuching Wastewater System job (awarded 1Q16) due to ground conditions. Lastly, although Pesona’s topline grew 85% YoY, this was lower than we had expected.

• ...and other firm specific reasons. For the other results disappointments, Edgenta incurred higher depreciation & amortisation charges following its acquisition of KFM and UEMS. While IJM’s construction division grew, overall group earnings were held back by plantations which suffered from high production cost and tax. Lastly, Mitrajaya suffered cost overruns for its projects at RAPID which dented margins.

• Few positive surprises. For the few results upside, they were all margin driven. Coming off a low base, WCT and Eversendai posted stronger than expected margin recovery. Apart from that, GKent continued to register strong margins from its LRT ext variation orders (VO).

• Orderbook levels remain healthy. Most contractors within our coverage continue to exhibit healthy orderbook levels with cover ratios exceeding 2x. This follows from the record level of contract awards to listed contractors of RM56bn in 2016. While 2017 YTD (Jan-Aug) sector job wins have normalised downwards as expected, the sum of RM15bn is still on track to meet our full year target of RM25bn with the LRT3 awards starting to roll out. As such, we remain positive on the sector’s outlook despite the higher than expected proportion of results disappointment.

Risks

• Soft domestic property market, leading to slower private sector contracts.

Rating

Maintain OVERWEIGHT

• We expect a strong revival in job flows next year, driven by several mega rail projects such as the ECRL, HSR and MRT3. The significance of these mega rail projects to the construction sector should not be underestimated. To illustrate, job wins hit a high of RM28bn in 2012 and RM56bn in 2016 when the MRT1 and MRT2 was rolled out.

Top Picks

• Our top picks are centred on the upcoming influx of mega rail projects. We favour Gamuda (BUY, TP: RM6.36) given its strong track record with civil rail projects (Northern Double Track, MRT1 and MRT2). We also like GKent (BUY, TP: RM3.73) as the only local player with an expertise in rail related systems.

Source: Hong Leong Investment Bank Research - 14 Sept 2017