A majority of the companies under our coverage reported 1Q20 earnings that were below market and our expectations. Aggregate net profit for the sector contracted 41% yoy, mainly due to slow progress billings and exceptional losses. Sector core net profit jumped 42% yoy, mainly due to strong core earnings growth for IJM Corp. We expect weaker core earnings in 2Q20 due to the full impact of the government’s Movement Control Order (MCO) on construction and property operations. We remain UNDERWEIGHT on the sector. Top BUYs are Sunway Construction (SunCon), AME and Taliworks.

A Majority of 1Q20 Earnings Were Below Expectations

Out of the 10 construction companies that we cover, 60% were below our expectations, 10% within our expectations and 30% above our expectations. Aggregate construction sector earnings contracted 41% yoy but grew 4% qoq in 1Q20. IJM Corp recognised net exceptional losses of RM95m and unrealised forex losses of RM91m in 1Q20 (4QFY20 for IJM), which dragged down sector earnings.

Weak Domestic Earnings for Construction Companies

Excluding the exceptional losses, sector core earnings jumped 42% yoy and 37% qoq in 1Q20. The lumpy overseas property earnings recognition for IJM and MRCB in 1Q20 boosted the sector core earnings. Excluding IJM’s contribution, sector core earnings contracted 7% yoy and 25% qoq in 1Q20. The domestic operations for most of the construction companies were weaker due to the MCO and slow public-sector project awards in 2019. The progress billings for construction and property projects had been adversely affected by the closure of construction sites since the MCO started on 18 March. Traffic volumes on toll highways fell 80-90% during the MCO period, which reduced the toll revenue and profits of concession companies.

Earnings Likely to be Worse in 2Q20

The full impact of the MCO will likely be felt in 2Q20 as construction sites were only allowed to restart work in early May. But the requirement for all foreign workers to be tested for Covid-19 infection before being allowed to work at construction sites delayed the restarting of construction operations. The disruption to supply chains from building materials to equipment supplies also contributed to the delay. Hence, we expect most construction companies to report weaker results in 2Q20.

Slow Earnings Recovery Expected

We expect a slow earnings recovery for the sector and most of our earnings forecasts were reduced following the 1Q20 results. At the start of the year, we had projected sector core EPS growth of 13% yoy in 2020, recovering from earnings contraction over the previous 2 years. Following the earnings cuts, we now expect sector core EPS to contract by 24% yoy in 2020, for the third year in a row, before recovering to a growth of 3% yoy in 2021.

Valuations Are Not Attractive

The sector core PER of 21x in 2020E is not attractive considering the slow earnings recovery. Hence, we reiterate our UNDERWEIGHT call on the construction sector. Our top BUYs remain SunCon, AME and Taliworks, which we believe are relatively more resilient to weather the cyclical downturn for the sector. Key upside risks are a faster-than-expected recovery in progress billings for ongoing construction projects and a revival of mega infrastructure projects such as the Klang Valley MRT Line 3 and Kuala Lumpur-Singapore High Speed Rail

Source: Affin Hwang Research - 6 Jul 2020