We are upgrading the sector from NEUTRAL to OVERWEIGHT premised on: (i) better earnings outlook due to minimal disappointments in the last reporting season, (ii) mega infrastructure news flow coming back to the limelight, (iii) and reasonably cheap current valuation for KLCON at 13.2x which is below its 5-year mean levels, which we believe is a decent entry point for investors to accumulate. Furthermore, outstanding order-book for most of the contractors within our coverage remains robust with more than 2-year earnings visibility, and we are also expecting higher job flows for 2018 of c.RM50.0b (excluding MRT3 and HSR) compared to RM36.2b in 2017. We continue to choose WCT (OP; TP: RM1.90) as our Top Pick for 2Q18 given that its share price seen an unprecedented low despite improving prospects.

On a continued downtrend… At our report cut-off date of 23-March-2018, we continue to see the average capital gains for stocks under our coverage on a downtrend, registering a negative return of 0.8% compared to the negative return of 5.5% in 4QCY17. This time around, we had added one stock into our coverage, i.e. GKENT in computing average returns for 1QCY18; should we exclude it for comparison, the negative returns for 1QCY18 would be wider at 2.6%. In 1QCY18, small-cap contractors registered negative return of 1.8% while big-cap contractors registered mild positive return of 0.4% over 4QCY17. As highlighted in our previous report dated 5-January-2018, we indicated that stocks like SUNCON, KIMLUN and KERJAYA are likely to see reversal in share prices, which materialised with negative returns ranging between 9%-15%. As for our Top Picks in the last quarter, i.e. WCT and MITRA, they continued to trend down with negative returns of 2-13% due to uninspiring result performance, especially for WCT, which surprised the market with an one-off provision.

Similar earnings trend. We saw similar trend in performance for the recently concluded 4QCY17 reporting season as compared to 3QCY17. Out of 11 construction stocks under our coverage, 2 contractors disappointed, 8 came in within/broadly within while only 1 came in above our expectations. The 2 contractors that disappointed are IJM and SUNCON. For IJM it was due to: (i) weaker than-expected property development margins, (ii) IJMPLNT’s slow production recovery in Sabah leading to higher-than-expected unit costs, (iii) lower-than expected industrial margins, and (iv) higher than-expected tax rates, while SUNCON was due to weaker-than expect billings from its precast division. Ytd-YoY, we have bulk of the contractors registering CNP growth ranging from 8% to 149% except for 4 contractors that saw decline in their CNP by the range of 14-27%. 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 non-construction related divisions i.e. property, plantation, industry, and (iv) provisioning of bad debts. QoQ-wise, we have 3 contractors that registered CNP decline of 5-19% due to similar reasons mentioned above. In terms of earnings revision, we lowered our FY18E CNP for IJM and WCT by 12-13%; as we factored in higher unit costs for plantation division, lower industry margins and lower development margins for WCT. Likewise, we raised KIMLUN and SUNCON’s FY18E CNPs higher by 2-4% as we factored in a higher billings progress. All-in, contractors’ performance within our core coverage for 4QCY17 was similar with 3QCY17.

Rail projects in the limelight. For 2QCY18, we are anticipating contract flows from two mega infrastructure projects, i.e. MRT3 and HSR with a combined estimated value of c.RM90.0b and the potential beneficiaries likely to be GAMUDA, MMC, GKENT, SUNCON, IJM and YTL. However, we do highlight that even if any of these players were to win the above-mentioned projects, we do not expect any earnings contribution in the near term as the physical works for these project is only expected to commence earliest by end 2019. Apart from MRT3 and HSR, we are also expecting news flow from mega infrastructure projects like ECRL (RM60.0b), Pan-Borneo Sabah (RM12.8b), 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 - 4 Apr 2018