A cloud of uncertainties emanating from a gloomy economic backdrop has blurred the construction sector outlook. In essence, sentiment on construction stocks will remain under siege from the Covid-19 spill-over effects and possible delays in the revival of mega infrastructure projects. The KLCON Index reacted by falling 37.2% YTD (until 20 March 2020), thus reversing last year’s gain of 34.2%.

With investor confidence battered badly and given poor earnings visibility, we have switched our valuation methodology to PBV. During the 2008/2009 Global Financial Crisis (GFC), the construction sector was then trading between –2SD and –1SD below the historical PBV mean for approximately three months. In comparison, the KLCON Index is currently trading at -2SD below its mean, suggesting limited downside risks.

After attaching basement PBV multiples at -2.5SD and -1.0SD below their mean levels, our revised target prices indicate positive returns to be made by investors in the medium term as valuations are expected to revert to normalcy post-crisis. From a fundamental perspective, our top stock picks are GAMUDA (OP; TP: RM3.18), SUNCON (OP; TP: RM1.80) and HSL (OP; TP: RM1.37). In addition, trading-oriented investors can consider WCT (OP; TP: RM0.47) and KIMLUN (OP; TP: RM1.25) as potential rebound plays from oversold territories. Upgrade sector call to tactical OVERWEIGHT on valuation grounds.

Double whammy hit. The Bursa Malaysia Construction (KLCON) Index slumped 37.2% YTD (until 20 Mar 2020) compared with the FBMKLCI’s YTD plunge of 18.0%. Leading the losses during this period were MUHIBAH (-66.5%), WCT (-63.8%) and KIMLUN (-56.0%) while HSL (-21.8%) and SUNCON (-26.4%) were the relative outperformers. Essentially, the underlying market sentiment has been rattled by the dire economic consequences on the back of the fallout from the Covid-19 pandemic, which has brought the entire global economy to an almost complete standstill. Investors also felt nervous about the abrupt change in government after the political upheavals in late February/early March.

Mega infrastructure projects under review? It remains to be seen whether the new Federal government (like its predecessor) will review existing and new major construction projects initially after they take office. Among the high-profile infrastructure projects that have been earmarked to be revived include: (i) the RM3.2b Johor Bahru-Singapore Rail Transit System (RTS) with the finalisation of contract terms previously scheduled to be in April this year, (ii) the ~RM60b Kuala Lumpur-Singapore High Speed Rail (HSR), which is supposed to be revisited by both countries in May 2020, (iii) the ~RM21b Mass Rapid Transit 3 (MRT3), earlier speculated to be considered for revival in the later part of this year, and (iv) the RM32b Penang Transport Master Plan (PTMP), with the project delivery partner or PDP agreement originally to be inked in 1QCY20 following the previous Federal government’s green light to guarantee the bond financing for the LRT component.

Will the government stimulate the economy via construction boost? In our view, the government is not expected to roll out mega infrastructure projects in the immediate-term to pump prime the economy. While there is logic to bank on construction activities to boost the economy given its wide multiplier effects, the government’s hands are essentially tied for the time being. Indeed, the federal government’s already tight financial position will be stretched further by lower revenue (following the oil price collapse and the plunge in tourist arrivals, export receipts) and increased spending (via stimulus measures to mitigate the Covid- 19 fall-outs). Consequently, our economics team is expecting the budget deficit to widen from 3.3% previously to 4.9% this year. In addition, there is the typical time lag for major construction projects to be implemented before we see the economic impact as the government’s most urgent priority at the moment is to alleviate the people’s burden by providing immediate financial support.

Look East strategy. With fewer sizeable job opportunities in Peninsular Malaysia in the meantime, it is going to be challenging for contractors to replenish their order-books going forward. One bright spot may be in Sarawak, where the state has budgeted to spend RM22b on infrastructure projects including the Second Trunk Road (RM6b), coastal road upgrades (RM5b), water grid programs (RM2.8b), rural electrification projects (RM2.4b) and telco towers (RM1b). Timing-wise, it would probably make political sense to roll out these projects to stimulate economic activity ahead of the Sarawak state election, which must be held by Sep 2021.

Shifting to PBV valuation methodology. We are changing our valuation methodology from PER to PBV in view of the low earnings visibility and battered market confidence. To get a sense on the valuation divergence during such abnormal time, going back to the 2008/2009 Global Financial Crisis (GFC), the construction sector was then trading between –2SD and –1SD below the historical PBV mean for approximately 3 months (Chart 1). In comparison, the KLCON Index is currently trading near 2SD below its PBV mean (Chart 2), suggesting limited downside risks. Hence, we tactically upgrade our sector call from NEUTRAL to OVERWEIGHT on valuation grounds.to tactical OVERWEIGHT on valuation grounds.

Source: Kenanga Research - 1 Apr 2020