Maintain our OVERWEIGHT rating on Construction sector. Despite the big caps (IJM and GAMUDA) becoming less attractive due to their heavy property exposure, the sector’s fundamental is still firmly backed by the following: (i) healthy contractors’ outstanding orderbook providing visibility for the next 2-3 years, (ii) orderbook replenishment prospects still bright over the near-long term driven by both buildings and infrastructure jobs, and (iii) most contractors have delivered/met earnings expectations (i.e. 72% our coverage), hence earnings risks are minimal. Given the sector’s firm fundamentals, we advocate investors to accumulate quality and value construction stocks with i.e. (i) strong orderbook with visibility of at least 2-3 years, (ii) minimal earnings risk i.e. high probability of meeting new orderbook replenishment expectations and sustainable margins, and (iii) compelling valuations. While we lowered our target PER for big cap to 16x from 18x previously (due to significant exposure in property sector), we maintain our target PER for small-mid cap of 10x-14x. Our Top Picks are MMCCORP (OP; TP: RM3.10), as a big-cap option, and MITRA (OP; TP: RM2.35), for small-mid caps.

KL Construction Index still outperforming benchmark. The KL Construction Index (+2.9% YTD) has continued outperforming the FBMKLCI (-2.5% YTD). MITRA was the top gainer (+89.8% YTD) amongst all contractors in our universe, thanks to the group’s growing orderbook and higher earnings base. Second runner-up was MUHIBAH, up 23.0% on a rebound play after being hit by the oil prices plunge last year. Meanwhile, NAIM (-21.1%) and WCT (-6.0%) continued to be the top losers in our construction space, dragged down by disappointing earnings and their significant exposure in property development.

Major news/events in 2Q15 vs. expectations. Amongst the major events in 2Q15, including the 11th Malaysia Plan (11MP), which were within expectations are: (i) announcement of big rail infrastructure projects such as MRT2, LRT3 and HSR in 11MP in May 2015, (ii) MRT2 went on public gallery, (iii) news flows on RM40.0b KL-Singapore HSR: both Singapore and Malaysia government agreed to proceed with the project although no timeline given, (iv) WCE highway works started being dished out to contractors (WZSATU), (v) new highway worth RM2.1b is expected to be built in the Klang Valley, (vi) news flows on Bandar Malaysia project (RFP issuance). Some news flows/events that we expected but did not materialise are more details on Kampung Baru Redevelopment, urban highway SUKE.

Quarterly earnings review and outlook. 1Q15 results were mostly within our expectation. Out of 11 stocks under our coverage, 8 were within, 1 above and the remaining 2 below. This set of results was far better than that of last quarter where half of our coverage came in below expectations. IJM and BENALEC were below expectations due to the former’s weak property profits as well as the latter’s delayed land sales. Going forward, we expect the momentum to continue with most of our coverage companies meeting our estimates driven by healthy orderbook, improved margins as well as being on track to meeting our replenishment assumptions. However, we remain cautious on big cap companies’ earnings namely: GAMUDA, IJM and WCT due to their significant exposure in property sector. Earnings-growth-wise, we estimate aggregate earnings for construction stocks under our coverage to grow by healthy 24.3% and 9.7% in FY15 and FY16, respectively.

Contractors’ outstanding orderbook still healthy, provide 2-3 years visibility. We like to highlight that outstanding orderbook of construction companies under our coverage are still healthy, providing 2-3 years earnings visibility. In fact, some of them even touched their record highs this year such as MITRA (RM1.9b vs historical range of RM300-500m) and SENDAI (RM2.0b vs historical range of RM1.0b). In terms of visibility, we gather that IJM, MITRA and MMCCORP have the highest, where their orderbook could last the group for the next 5 years. Meanwhile, the poorest visibility is HSL where its RM870m orderbook could only last them until next year.

Orderbook replenishment prospects still bright over near-long term driven by both buildings and infrastructure segments. Among the contract flows that will likely to happen over the next 3-6 months are: (i) buildings jobs i.e. high rise or affordable housing jobs. This will benefit those building contractors such as MITRA, KIMLUN, SUNCON and WCT, (ii) infrastructure jobs, i.e. roads, highways, water, marine-related works and civil foundation works which will benefit construction names such as HSL, MUHIBAH, and WCT, (iii) specialized structural steel for KL118 tower, which will benefit SENDAI, (iv) piling jobs for some high-rise property jobs and key beneficiaries are piling players such as ECONBHD and PTARAS.

Meanwhile, on news flows, we expect: (i) the PDP for Penang Transport Master Plan (PTMP) to be announced in 3Q15, (ii) the PDP for the RM9.0b LRT3 project to be announced within 3-6 months from now, (iii) the PDP for MRT2 project secured by MMC-GAMUDA last year will be signed in the next 3 months while the tender will start to be called by end of 2015, (iv) more news flows on Bandar Malaysia project, and (v) more news flows on DASH highway. In terms of direct beneficiaries, as for PDP of PTPM, GAMUDA has higher chance securing the role given that it is one of 2 shortlisted contractors. As for RM9.0b LRT3, both MRCB-George Kent JV and SUNCON could be the front-runners due to their track record in LRT Extension.

Given that these projects are rather sizeable, by large, the whole sector will benefit. In specific, the existing MRT1 and LRT extension contractors should benefit from MRT2 and LRT3. Meanwhile, contractors with expertise in site preparation and earthworks such as WCT, SUNCON and GADANG will benefit from the initial stage of construction of Bandar Malaysia. Meanwhile as for DASH highway construction jobs, it will also benefit highway builders namely IJM, GAMUDA, WCT, BPURI, AZRB, MRCB, GADANG, MUHIBAH, MUDAJYA and PESONA. As for more specialized works such as segmental box girders (for MRT and LRT), foundation and sub-structure piling works and structural steel works (super structure building), SENDAI, KIMLUN, PTARAS and ECONBHD should benefit. 

Source: Kenanga Research - 2 Jul 2015