We are maintaining our OVERWEIGHT stance on the Construction sector in 3Q13. We believe the sector is still experiencing a boom, and more so after GE13. The sector’s investment case for 3Q13 are: 1) construction is still in an up-cycle, as construction GDP continue to record double-digit growth of 14.7% in 1Q13, 2) the sector is also seeing a continuity of positive news flows coming from railways, highways, O&G-related constructions, mixed developments and SCORE-related projects, which will provide replenishment prospects to contractors, 3) the higher 1Q13 productivity growth of 15.5% YoY recorded by the sector is promising and indicates execution is becoming less of an issue and 4) selective quality contractors’ valuations are  still undemanding and with healthy fundamentals. For the big-cap construction segment, we still prefer Gamuda (OP, TP: RM5.30) given its clear earnings visibility vis-à-vis its still cheap valuation (i.e. 14.7x FY14 against its historical average of 18x). As revealed during  our Market Strategy (2/7/13), Muhibbah (OP; TP: RM1.90) is our top pick in the small-mid cap space as it is the best proxy to leverage on the booming construction and O&G sectors; but post our Market Strategy report yesterday, Muhibbah’s share price shot up and almost hit our TP within a day. We may review our TP with an upside bias pending our next company visit. 

Contractors delivered a mixed set of 1Q13 results. Six out of the twelve stocks under our coverage delivered weaker than expected 1Q13 results. The small-cap contractor results from FAJAR (OP, TP: RM0.82), BPURI (MP, TP: RM0.78), EVERSENDAI (TP: RM1.68), BENALEC (OP, TP: RM2.08) and TRC (OP, TP: RM0.75) all came in below expectations as they  were hit by (i) squeezed margins, (ii) lower than expected construction activities and (iii) delays in their billings progress. As for the large-cap contractors, most of their results were in line but as expected, WCT (OP, TP: RM2.61) and Gamuda (OP, TP: RM5.30) incurred additional costs arising from arbitration awards that went against them. Meanwhile, MRCB’s (MP: RM2.08) earnings were lower in 1Q13 but this is not a major concern as some of its projects construction in KL Sentral had just only commenced, hence the lower sales recognition.

Expect stronger earnings in 2Q13. We expect the small-cap contractors’ earnings to improve YoY in 2Q13 given the fact that they will now be able to execute their projects in full swing (i.e. the LRT extension) without further complications. As for the big-cap contractors, we expect Gamuda’s core earnings (excluding its one-off litigation cost) to deliver another record-breaking year in FY13 (FYE: July). We also expect IJM Corp to start its new 1QFY14 (FYE: March) with strong numbers driven by its construction and property divisions, while notably, its plantations division is one of the best performing planters in town as IJMPLANT has beat estimates 2 quarters in a row. On the other hand, we may see MRCB delivering weaker results again in 2Q13 as we expect it to post stronger earnings only from 2H14 onwards. 

What is in store for contractors?  We expect some “goodies” for contractors in 2H13 which will materialize from the following: 1) MRT2 alignment to be approved by Cabinet in July  2013, 2) 118-storey Warisan Merdeka tower contracts awards,  3) high-speed railway news as we expect its feasibility study to be completed soon, 4) awards of highway projects (i.e. SUKE, DASH, etc.), 5) other rail-related projects in Klang Valley (i.e. KL monorail extension, KV Double Track, etc.), 6) SCORE-related infrastructure jobs  and 7) Pan-Borneo Highway.

Maintain OVERWEIGHT with selective picks.  As for 3Q13, we prefer quality contractors (i.e. those with strong earnings delivery, bright prospect and  strong financials) that still have undemanding valuations. As such, for the big-cap construction segment, we still prefer Gamuda (OP, TP: RM5.30) given its clear earnings visibility vis-à-vis its still discounted valuation. We reaffirm our view that Gamuda will be the biggest beneficiary of the rail-infrastructure story. As revealed during our Market Strategy (2/7/13), Muhibbah (OP; TP: RM1.90) is our top pick in the small-mid cap space as it is the best proxy to leverage on the booming construction and O&G sectors, and has recently obtained a Petronas license for O&G Onshore Fabrication while its 61.8% owned Favelle Favco (NOT RATED) is an effortless icing.  However, post our Market Strategy report yesterday, Muhibbah’s share price shot up by 6.4% in the afternoon and almost hit our TP – but share price settled at RM1.82 by end of the day. We may review our TP with an upside bias pending our next company visit. We also have OUTPERFORM calls on Naim Holdings Berhad (TP: RM4.45), Kimlun Corp (TP: RM2.28), Eversendai Corp (TP: RM1.68), TRC Synergy (TP: RM0.75), MRCB (TP: RM2.08), Fajarbaru Builder (TP: RM0.82), Benalec Holdings (TP: RM2.08) and MARKET PERFORM on IJM Corp (TP: RM5.90), WCT BHD (TP: RM2.61), MMC (TP: RM2.67) Bina Puri (TP: RM0.78).

Source: Kenanga