We  remain  OVERWEIGHT  on  the  construction  sector  despite  a generally  subdued  3Q13  reporting  season.  We  find  comfort  in  the sector’s strong  prospects as it rides on what we believe is an extended upcycle  backed  largely  by  the  MYR73bn  Klang  Valley  MRT  project,which will keep players busy until 2019. Our Top Picks in this sector are Gamuda, Pintaras Jaya and Protasco.

• A  generally  disappointing  3Q13.  The  latest  quarterly  results  of  the construction companies were generally disappointing. Of the 11  stocks under our coverage universe  that  reported results, six  (55%)  missed our forecasts, four (36%) met our expectations, while only one (9%) beat our projection  (compared  with  27%  below,  73%  within  and  none  above  in 2Q13).
• Sector  on  an  extended  upcycle.  Nonetheless,  the  prospects  for  the construction  sector  remain  strong  as  it  rides  on  what  we  see  as  an extended  upcycle  backed  largely  by  the  MYR73bn  Klang  Valley  MRT project.  With  Line  1  worth  MYR23bn  currently  under  construction  and Lines 2 & 3 worth MYR25bn each under planning, this mammoth project will  keep  players  busy  until  2019.  That  said,  from  a  risk  angle,  we  do acknowledge  that  the  Klang  Valley  MRT  project  is  the  sector’s  lifeline over  the  medium  term.  As  such,  it  is  extremely  crucial  that  the Government  does  not  backpedal  on  its  commitment  to  its implementation,  and  equally  important  is  the  timeliness  of  project execution.
• Maintain  OVERWEIGHT.  We  advocate  a  two-pronged  stock-picking strategy,  ie  go  for  high-beta,  highly  liquid  big-cap  Gamuda  (GAM  MK, BUY,  FV:  MYR5.45)  that  will  take  the  lead  in  reacting  to  new  price catalysts (such as  Cabinet approval for Line 2  of the Klang Valley MRT project),  and  undervalued and under-researched small-cap stocks such as:  i)  Pintaras  Jaya  (PINT  MK,  BUY,  FV:  MYR7.00),  which  has  good piling  rates  due  to  capacity  shortage  in  the  market,  and  ii)  Protasco (PRTA MK, BUY, FV: MYR1.80) as its  100-acre university campus land in  Bangi  is  already  ripe  for  redevelopment,  coupled  with  its  strong construction pipeline

Partial Earnings Eclipse In 3Q13
3Q13  generally  disappointing.  The  latest  quarterly  results  of  the  construction companies  were  generally  disappointing  (see  Figure  1  which  also  shows performance of companies against consensus estimates). Of the 11 stocks under our coverage universe  that  released  their  results,  six  (55%)  missed  our  forecasts,  four (36%)  met our expectations, and only one  (9%)  beat our projection  (compared with 27%  below,  73%  within  and  none  above  in  2Q13).  For  Mudajaya  (MDJ  MK, NEUTRAL,  FV:  MYR2.85),  TRC  Synergy  (TRC  MK,  BUY,  FV:  MYR0.71)  and Gabungan AQRS  (AQRS  MK, SELL, FV: MYR0.95), the key reasons for the poor results  include  slow  billings  and  cost  pressure  on  the  back  of  constrai nts  in construction  resources  like  labour  and  equipment.  Eversendai  Corp  (EVSD  MK, BUY, FV: MYR1.46)  was let down as it was unable to immediately recognise chunky variation  order  (VO)  claims  while  Ahmad  Zaki  Resources  (AZR  MK,  BUY,  FV: MYR1.33)  made  a  lumpy  provision  for  receivables.  Meanwhile,  Naim  (NHB  MK; BUY, FV: MYR5.63)’s results were weighed down by weaker  earnings from 33.6%-owned  Dayang  Enterprise  (DEHB  MK,  BUY,  FV:  MYR6.72),  attributed  to  lumpy mobilisation  costs  for  new  projects.  The  bright  spots  were  IJM  Corp  (IJM  MK,  NEUTRAL,  FV:  MYR6.21),  which  beat  our  forecast  on  stronger-than-expected property profits, as well as WCT  (WCTHG MK, SELL, FV: MYR2.21),  Pintaras Jaya(PINT  MK,  BUY,  FV:  MYR7.00),  Hock  Seng  Lee  (HSL  MK,  NEUTRAL,  FV: MYR2.06)  and  Protasco  (PRTA  MK,  BUY,  FV:  MYR1.80)  –  all  of  which  delivered positive earnings. We cut our FY13 forecasts for companies that missed expectations by 10-41%, and either maintain or cut their FVs by 17-18%. We maintain our calls on all  stocks  other  than  WCT,  which  we  downgraded  to  SELL  (from  Neutral)  on valuation grounds.

Sector on extended upcycle. Nonetheless, the prospects for the construction sector remain strong as it rides on what we believe is an extended upcycle, propelled largely by the  MYR73bn Klang Valley  MRT project. With Line 1 worth MYR23bn  currently under  construction  and  Lines  2  &  3  worth  MYR25bn  each  under  planning,  this mammoth  mega  project  will  keep  players  busy  until  2019.  That  said,  from  a  risk angle, we do acknowledge that the Klang Valley MRT project is the sector’s lifeline over the  medium term. As such, it is extremely crucial that the Government does not backpedal  on  its  commitment  to  its  implementation,  and  equally  important,  the timeliness of project execution.

MRT reverberates along entire sector value chain.  Given its scale, the impact of the Klang Valley MRT project can be felt along the sector’s entire value chain. Line 1, for  instance,  has  given  rise  to  orders  to:  i)  project  delivery  partners  (PDPs)  MMC Gamuda  –  MMC  (MMC MK, NR) and  Gamuda  (GAM MK, BUY, FV: MYR5.45); ii) the  tunnelling  contractors  (again,  MMC-Gamuda);  iii)  the  viaduct/station/depot contractors  –  IJM Corp,  Sunway  (SWB MK, BUY, FV: MYR3.30), Mudajaya, TRC, TSR (TSRC MK, NR), Naim, Gadang (GADG MK, NR), UEM, Ahmad Zaki, MTD and Gabungan AQRS; iv) the piling contractors  –  Pintaras Jaya and Econpile; v) a long list of smaller and mostly privately-owned contractors; and vi) segmental box girders and  tunnel  lining  segments  suppliers  like  Kimlun  (KICB  MK,  BUY,  FV:  MYR2.36). Meanwhile, Lines 2 and 3 are expected to have  the same profound impact on the sector.

Other mega projects deferred.  In the wake of warnings from an international rating agency of a potential sovereign rating downgrade, there is a risk that the Government may defer certain mega projects other than the  Klang Valley MRT project to narrow its  fiscal  deficit  and  prevent  further  weakening  of  its  current  account.  Already,  the Government has said that projects with low import content and high multiplier effects will  be  given  priority,  while  those  with  high  import  components  will  be  “sequenced accordingly”.  As  the West  Coast  Expressway  (WCE),  the  refinery  &  petrochemical integrated development (RAPID) in Pengerang, Johor, and the Gemas -Johor Bahru double track were specifically mentioned in the Budget 2014, we  believe that these projects carry a lower risk of being deferred. This leaves us with “prime suspects”, namely, the Tun Razak Exchange (TRX), Bandar Malaysia (the redevelopment of the Sg  Besi  Airport),  the  Warisan  Merdeka  Tower  (the  redevelopment  of  Stadium Merdeka and its surrounding area) and the Kuala Lumpur-Singapore high-speed rail link. Nonetheless, we are not overly concerned as none of these are critical as a source of jobs for the sector like the Klang Valley MRT project. Mega property projects suc h as TRX, Bandar Malaysia and Warisan Merdeka Tower, for instance, will benefit largely earthworks  and  high-rise  building  specialists  such  as WCT,  Sunway,  Gadang,  IJM and Ahmad Zaki. On the other hand, the West Coast Expressway will largely benefit IJM and its subcontractors, including WCT.

Gross  development  expenditure  down  marginally.  Meanwhile,  Budget  2014 projected  the  year’s  gross  development  expenditure  at  MYR44.5bn,  down  slightly from  2013’s  MYR45bn  estimate.  The  biggest  recipients  of  the  allocation   are  rural infrastructure  (MYR4.1bn,  including  MYR500m  for  the  much -talked-about  PanBorneo  Highway),  rail  projects  (MYR2.9bn),  affordable  housing  (MYR1.7bn),  five regional  corridors  (MYR1.6bn),  airports  (MYR1bn),  schools  (MYR831m)  and  flood mitigation  (MYR659m)  (see  Figure  2).  We  see  sustained  gross  development expenditure as a “safety net” for the construction sector.

Maintain OVERWEIGHT.  We advocate a two-pronged stock-picking strategy, ie  go for high-beta,  highly liquid big-cap  Gamuda that will take the  lead in  reacting  to new price catalysts (such as cabinet approval for Line 2 of the Klang Valley MRT project), and  undervalued and under-researched small-cap stocks such as: i)  Pintaras Jaya,which has good piling rates  due to  capacity shortage in the market, and ii)  Protasco as  its  100-acre  university  campus  land  in  Bangi is  already  ripe  for  redevelopment, coupled with its strong construction pipeline.

Source: RHB