We reiterate our NEUTRAL call on the sector for now, as we remain cautious ahead of the upcoming reporting season in Feb 2018. However, we do look to forward to upgrade the sector closer to 2QCY18 if: (i) >70% of covered contractors’ results come in within expectations, ii) valuation for KLCON remains reasonably attractive at below +1SD level, and (iii) news flow for mega infrastructure projects i.e. ECRL, Pan Borneo Sabah and HSR picks up. As for 1QCY18, we expect news flow to be slow except for LRT3 awards news flow given that the PDP is targeting to finalise all the awards by the end of 1QCY18.

Share price performance tapered down… At our report cut-off date of 15-Dec-2017, we saw the average capital gains for the stocks under our coverage continuing its downtrend registering negative return of 5.5% compared to negative returns of 5.7% in 3QCY17. This time around, it was the big boys that registered higher average negative returns of 9.5% over small-mid caps’ average negative returns of 2.8%. However, we still see contractors, i.e. SUNCON, KIMLUN and KERJAYA beating the negative trend registering positive returns ranging between 4.5% and 8.2%. As highlighted in our previous strategy report, we believe that a reversal in share prices was imminent as the KL Construction Index (KLCON)’s valuation was fairly rich at 15.7x (+1.5SD levels) back in 3QCY17 without much catalyst and news flow. In terms of year-to-date performance, KLCON’s gain of 9.7% still outperformed KLCI’s gain of 5.6%.

Improved performance in 3QCY17. We saw better performances in the recently concluded 3QCY17 reporting season. Out of 10 construction stocks under our coverage, 2 contractors disappointed, 6 came in within/broadly within while the remaining 2 were above our expectations. The 2 contractors that disappointed are IJM and KIMLUN. For IJM it was due to: (i) higher unit costs incurred by IJMPLNT, and (ii) weak property margins, while KIMLUN was affected by provisioning of bad debt. The number of stocks that disappointed in 3QCY17 is the same as 2QCY17. YoY, bulk of the contractors registered CNP growth ranging from 8% to 56% except for 4 contractors that saw decline in their CNPs by the range of 10-29%. The decline in the performance for these 4 contractors, i.e. HSL, KIMLUN, MITRA, and IJM were due to: (i) slow progress billings for on-going projects, (ii) cost overruns due to delays, (iii) being dragged down by other nonconstruction divisions i.e. property and plantation, and (iv) provisioning of bad debts. QoQ wise, we have 3 contractors that registered decline of 13-15% in their CNP due to similar reasons mentioned above. In terms of earnings revision, we lowered our FY17E earnings for IJM and KIMLUN; as we factored in higher unit costs for plantation division and lower property development margin for IJM, and the provisioning of bad debt for KIMLUN. All-in, contractors’ performance within our core coverage was better in 3QCY17 vis-à-vis 3QCY17 with more upgrades changes to our FY17-18E core earnings forecast, recommendation and Target Price.

What’s for 2018? As highlighted in our previous strategy report, we had been anticipating slower contract flows at the range of c.RM30.0b for listed construction players in CY17 which came in within our expectations thus far given that we only saw RM36.4b worth of jobs clinched by listed players in CY17, down by 36%, YoY. In terms of jobs flow expectation for 2018, we are expecting higher value of jobs to be dished out to listed contractors closer to range of RM50.0b, backed by mega infrastructure projects like ECRL (RM60.0b), remaining contracts from LRT3 (c.RM3.0-4.0b), Pan-Borneo Sabah (RM12.8b), KL-SG High Speed Rail (c.RM50.0-60.0b) and government housing jobs, while jobs from the private sector would be from projects like Bukit Bintang City Centre and new development launches with beneficiaries such as IJM, SUNCON, GAMUDA, AZRB, GADANG and KERJAYA.

Source: Kenanga Research - 5 Jan 2018