We reiterate OVERWEIGHT on the Construction sector. Lending support to our bullish view is the announcement of 11th Malaysia Plan (11MP), in less than two months, which is crucial being the last leg of the country’s vision to become a high-income nation in 2020. It is also the last 5-year chapter of the Economic Transformation Programme (ETP) that was announced back in 2010. Hence, we believe the government will most likely announce remaining projects that are yet to be implemented in ETP so far in the 11MP announcement. In terms of beneficiaries, by large, we reckon the whole sector will benefit in general leading to a sector’s rerating. This is historically backed by the stellar performance of KL Construction Index after the government announced both 9MP and 10MP in 2006 and 2010, respectively. Among the mega projects we expect the government to announce in 11MP are: (i) KL-Singapore High-Speed Rail (RM40.0b), (ii) Kampung Baru Redevelopment (RM61.0b), (iii) Bandar Malaysia (RM50.0b), (iv) MRT Line 2 and 3 (RM50.0b), new highways (RM20.0b), and LRT3 (RM9.0b). While all these mega projects may not be executed immediately in the near-term, we could still see more job flows in the next 3-6 months. Above all, given the mixed set of results in the latest reporting quarter, we continue advocating investors to be selective, i.e pick contractors that: (i) has strong orderbook, (ii) face minimal earnings risk i.e high probability of meeting new orderbook replenishment expectations and sustainable margins, (iii) will benefit from the news/contract flows in 2015, and (v) have compelling valuations. Our top pick for big caps is IJM (OP; TP: RM8.00) and MMCCORP (OP; TP: RM3.03). Meanwhile for mid-small cap pick, we pick MITRA (TB; FV: RM2.37).

The KL Construction Index (+6.9% YTD) has continued outperforming the FBMKLCI (-3.4% YTD). This time around, BENALEC was the top gainer (+42.5% YTD) amongst all contractors in our universe, thanks to the announcement of Tg Piai’s project getting the DEIA approval. Second runner-up was MUHIBAH, up 13.9% on a rebound play after being hit by oil prices plunged last year. Meanwhile, WCT (-7.6%) and NAIM (-6.0%) were the top losers in our construction space so far dragged down by disappointing earnings.

Major news/events in 1Q15 vs. expectations. Amongst the major events that happened in 1Q15, which were within expectations are: (i) six contractors have been shortlisted for PDP role in the RM9.0b LRT3, and (ii) RAPID sub-contract works being dished out again (Muhibbah). Meanwhile, few unexpected events in 1Q15 were: (i) MRT2 re-alignment which will cause a slight delay for the project for another 3-6 months, and (ii) Selangor state government decided to cancel Kidex highway. We also expected the RM700.0m Phase 2 of Kuching Wastewater Treatment Plant to be dished out in 1Q15 which did not materialize.

Quarterly earnings review and outlook. To recap, 4Q14 results season were mixed where from 10 stocks under our coverage, 30.0% were within, 30.0% above, and the remaining 40.0% below expectations. This time around, 4 stocks (NAIM, WCT, HSL, and MUHIBAH) were below expectations. They were largely hit by low construction margins and weak property numbers. Going forward, we reaffirm our view that contractors with weak margins or exposure to the property market may see greater earnings risks. Although we have already imputed in the risks in our earnings models, i.e. conservative assumptions on construction margins and lower property sales, we still remain cautious due to their persistent earnings disappointments. Earnings-growth-wise, we estimate aggregate earnings for construction stocks under our coverage to grow by 11.0% and 10.1% in FY15 and FY16, respectively.

Getting ready for 11MP. Prime Minister is expected to announce 11MP in May 2015. Hence, it is now less than 2 months away to the announcement. The 11MP is crucial for the country as it is the last leg of the country’s dream to become a highincome nation in 2020. It is also the last 5-year chapter of the Economic Transformation Programme that was announced back in 2010. Hence, we believe the government will most likely announce the remaining projects that have yet to be implemented in ETP so far such as: (i) KL-Singapore High-Speed Rail (RM40.0b), (ii) Kampung Baru Redevelopment (RM61.0b), (iii) Bandar Malaysia (RM50.0b), (iv) MRT Line 2 and 3 (RM50.0b), new highways (RM20.0b) and LRT3 (RM9.0b).

Source: Kenanga Research - 3 Apr 2015