The construction sector has been on a sideway downwards trend since 2011. Although there were brief rallies in between, it was not sustainable as the share prices retraced after the announcement of new contract wins and was more for trading purposes by various investors.

What caught our attention was the divergence in P/E multiples between the KLCI and construction sector. The KLCI continued to climb to new highs with an average P/E multiple of 14.8x since 2011, while the construction sector’s P/E multiple compressed from as high as ~16x to 10.8x. As it stands, the discount gap between the KLCI (P/E: 14.9x) and KLCON (P/E: 10.8x) P/E ratio is ~27%.

Investors are currently underweight in the construction sector due to uncertainty of the outcome in the next General Election which is rumoured to be held in November this year.

We believe that the risk of the General Election have been largely priced into the sector’s share price given the underperformance since 2011 and widening valuation gap versus the KLCI. The upside potential through narrowing of valuation gap and pent-up demand for the sector post-election outweighs the downside risks. Hence, we are maintaining our OVERWEIGHT stance on the sector.

Our top picks are:

• Gamuda (BUY; TP: RM3.81)
• IJM (Trading BUY; TP: RM5.48)
• WCT (BUY; TP: RM3.31)
• MRCB (BUY; TP: RM2.29)

Source: Hong Leong Investment Bank Research - 13 Sept 2012