Maintain OVERWEIGHT on Construction as we see more contract awards and news flows coming out in 3Q12. This is premised on the upcoming Budget 2013 in September 2012 and likely front-loading of contract awards prior to the upcoming general election. Assuming general election takes place in August or November 2012 (based on the school holidays timetable), the risk premium for construction will definitely be higher, and thus stock selections would be crucial for investors who wish to have exposure in the sector. We opted for fundamentally strong contractors with a strong balance sheet, as well as, being potential beneficiaries of the  upcoming  KLFID  and  EDTP  Gemas-JB  projects  like  WCT  (OP;  TP:  RM3.92)  and Gamuda  (OP;  TP:  RM4.12).  We  expect  more news and contract awards from the KLFID projects (foundation works), EDTP Gemas ' JB project and High Speed Train (HSR) project in 3Q12 and we reckon WCT and Gamuda will be in the limelight. Our Top Pick for the sector is WCT (OP; TP: RM3.92) and Gamuda (OP; TP: RM4.16).       

Contractor's 1Q12 results within expectations. Most of the big cap contractors under our coverage have reported in-line 1Q12 results,  except for MMC given its escalating operating cost incurred during the period. The sector's underperformers mainly comprised of small contractors like Bina Puri, Fajarbaru and TRC.  This is mainly due to the delays from the ongoing LRT extension works, which are already 9 to 12 months behind schedule. 

What to expect for 2Q12 earnings?  The 2Q12 results will be announced in August 2012. We believe that the downgrades during 1Q12 result season have already reflected the potential delays in revenue recognition for most small to mid cap contractors. On a positive note, we understand that the LRT extension project has received full Development Order (D.O) from the state government in June 2012 and the construction activities are expected to quickly pick up pace in 2H12. 

New mega project awards in 2H12.  Based on the recent news flows, Suruhanjaya Pengangkutan Darat (SPAD) is committed to invest about RM160b in improving the railway system in Malaysia until 2020. Based on that amount, we believe that this will include projects like the MRT circle line project, EDTP JB-Gemas (RM7b) and High Speed Railway (HSR) (RM30b). Among these projects, the imminent project for tenders will be EDTP Gemas-JB as we believe that the government is at the advance stage of discussion to finalize the details. For HSR, we understand that the project is now slated for completion by 2018 and we expect that there will be more news flows rather than tenders until end of the year (2012). We understand the timeframe for MRT circle line to execute  or award the project is 2Q13, meaning, the finalized alignment should be announced in 2H12. 

3Q12 will be challenging for smaller contractors. We believe there are still pocket of weaknesses due to their likely softer 2Q12 earnings (scheduled release in Aug-12) given delays in execution. This may drag down investors' sentiment on small cap players. However, we still remain positive in the medium term as earnings will flow through to 3Q12 earnings onwards.  We continue to like  Fajarbaru (OP; TP: RM1.27), Bina Puri (OP; TP: RM1.24), TRC (OP; TP:RM0.82) and MRCB (OP; TP:RM2.71).

Budget 2013 expectations.  Budget 2013 may not expect major project announcements if GE comes after Budget 2013. This is mainly due to the election budget where the government will likely dish-out more goodies to the 'rakyat' and perhaps, more to people-centric policies. We think that there is lot of execution activities needed for the existing and upcoming ETP projects which should provide ample growth for contractors in the next 1 to 2 years. Should there be any major projects announcements, we believe that they will likely be based on Public-Private-Partnership ('PPP') which is likely to benefit the big boys due to their strong balance sheet positions ie: WCT, Gamuda, MMC and IJM Corp.

Source: Kenanga