Our investment thesis that construction would be a key driver to catalyse an economic recovery would be more pronounced as Budget 2021 and 12th Malaysian Plan approaches in Nov 2020 and Jan 2021, respectively. KLCON is presently trading at forward FY21E PER of 12.6x and could re-rate to a high of 17x times in anticipation of the roll-out of mega infra jobs. That said, we expect contractors’ 2QCY20 results (being the MCO peak) to continue disappointing, albeit just a temporary hiccup to our projected rally. Maintain Overweight with picks being Gamuda, Suncon, Kimlun and Kerjaya.

1QCY20 results review. Despite already lowering our expectations in our construction strategy report early June (link to report: https://bit.ly/200602ConSU), 5 out of 11 contractors under our universe still came in below expectations. Needless to say, the MCO induced by the Covid-19 crisis had hit earnings harder-than-expected which caused contractors to book in less progress recognition and margins.

The key towards economic recovery. We stick to our investment thesis that construction sector will be a key lever the government of Malaysia can pull to accelerate an economic recovery amidst the Covid-19 crisis. This can be done via expediting existing projects and the introduction of new mega projects to keep future pipelines filled as jobs like MRT2 approach its tail-end. Since the RMCO in June, most contractors have gradually re-started operations at various paces with an aim to fully normalize operations by 4QCY20.

More legs for KLCON Index. As of 30th June 2020, KLCON Index (closed at 170) is trading at FY21E PER of 12.6x – at its 3- year mean. We think the sector’s market appeal will gradually increase as we approach Budget-2021 (in 6th Nov 2020) and 12th

Malaysian Plan (Jan 2021) in anticipation of the potential roll-out of mega infrastructure projects namely MRT3, Pan Borneo Sabah, RTS and potentially HSR. During this time, we believe it is probable for KLCON Index to re-rate to 17x PER (or +2SD above mean) and hit 230, providing 35% upside from current levels.

But... anticipate another round of disappointments first. Despite the earnings cut post 1QCY20 results, street’s expectations for FY20 is still 18% above ours which we find rather elevated (refer to figure 1). Therefore, we think that results for 2QCY20 (when MCO was at its peak season in late August) –, would continue to disappoint the market and could serve as a temporary hurdle to our projected rally.

Maintain OVERWEIGHT. Overall, construction remains a cyclical sector of which stock price rallies tends to precede news flow. Therefore, with contract flows still in its infancy stages, we find it fitting to build positions into the sector now. Our top picks for big caps are GAMUDA and SUNCON whereas our small/mid-cap picks are KIMLUN and KERJAYA. Key risks to our call include: (i) snap elections, and (ii) resurgence of Covid-19 cases.

Source: Kenanga Research - 8 Jul 2020