We reaffirm our OVERWEIGHT rating on the Construction sector as we believe that orderbook replenishment prospects for contractors going forward should remain bright propelled by several high-value projects. Firstly, the RM25b KVMRT2 project which was recently approved by the Cabinet. Even though the rail project will only be awarded sometime next year, we expect another string of news flows associated with KVMRT2 (i.e. alignment introduction, public gallery, tender process) in the next 6-9 months which should spur some trading interests on existing MRT contractors. Secondly, we understand that the award of the RM6.0b West Coast Expressway (WCE) is expected to materialize soon over the next 1-3 months. Thirdly, we expect infrastructure-related contracts from downstream oil and gas projects, i.e. RM60b RAPID to be awarded soon. This might benefit some contractors with ready presence in the project or contractors that have strong track records with the project owner, Petronas. Fourthly, we expect the proposed restructuring of water assets in Selangor to be completed soon and this will finally lead to the construction of Langat 2 water treatment plant and distribution system (LRAL2). Other than that, we also expect the Sarawak’s infra-related projects to be awarded soon driven by the state’s continued urbanization and industrialization process. Nonetheless, these positives have yet to be fully priced in as the KL Construction Index is still currently trading at 12.2x Fwd. PER, 11% discount to its mean. Hence, we advocate investors to selectively pick quality stocks that will ride on the expectations of news and contract flows. Our top pick remains IJM Corp (OP; TP: RM6.71) due to (i) it being a prime beneficiary of the soon-to-be awarded WCE project that will complement its other businesses, (ii) IJM Plant’s bright outlook driven by higher CPO price, and (iii) valuation still cheap vis-à-vis its historical average (Fwd. PER of 12.0x against 5-year historical PER mean of 15.1x). We also continue to favour MUHIBBAH (OP; TP: RM3.00) and GADANG (NR) for the RAPID infrastructure works. Meanwhile, CMSB (Not Rated), NAIM (OP; TP: RM4.15), and HSL (Not Rated) will still be favourite counters for Sarawak growth story.

Results review and outlook. Majority of contractors delivered disappointing results in FY13. Out of 9 stocks under our coverage, 4 underperformed, 3 outperform while 2 met expectations. Amongst the reasons for the general earnings disappointment are the lower-than-expected burn rate of orderbook, higher-than-expected operating expenses, i.e. electricity, raw material prices, unclaimed VOs, and provisions. We also downgraded KIMLUN to UP from MP due to dilution impact following its rights issue exercise recently. Most contractors have raised their concerns on the shortage of labours and subcontractors, which affected their margins and orderbook progress. Our checks with contractors revealed that they have been proactively addressing these issues. Going forward, regardless of the issues and concerns currently being addressed, we estimate aggregate contractors’ earnings in 2014 will rise by 15.6% driven by their healthy unbilled orderbook of more than RM25b.

Orderbook replenishment prospects still bright. Underpinned by strong orderbook replenishment prospects, remain bullish on the sector as we believe the industry fundamental is still bright given the following high-value projects in the pipeline such as the followings; (i) As expected (refer our 1Q14 Construction strategy report), the RM25b KVMRT2 project has been approved by the Cabinet. Although project works will only be awarded next year, we expect a fresh string of news flows associated with the KVMRT2 (i.e. alignment introduction, public feedback, tender process) in the next 6-9 months which should spur some trading interests on existing MRT contractors, (ii) The awarding of the RM6.0b West Coast Expressway (WCE) project is expected to materialize soon in the 2Q14. We reaffirm our view that the project will benefit IJM (main contractor), WCT, Muhibbah and Gadang, (iii) We gather that the infrastructure-related contracts from oil and gas projects, i.e. RM60b RAPID, are soon to be awarded and this might benefit contractors that already have presence in the project or have strong track record with the project owner, Petronas such as MUHIBBAH and GADANG, (iv) The construction of Langat 2 water treatment plant and distribution system (LRAL2) is expected to be take off in 2Q14 after the proposed restructuring of water assets in Selangor is completed in the next 1-2 months. This might benefit AZRB, MMC and SALCON as contractors for the plant and pipeline distributors such as ENGTEX, YLI, HIAPTECK, and JAKS, and (v) the Sarawak’s infra-related projects (access roads, water treatment plants, power plants) will continue due to the urbanization process in key state’s cities (i.e. Kuching) and industrialization in SCORE areas.

Positives have yet to be fully priced-in. As the KL Construction Index is still trading at discount to its mean, i.e. (12.2x Fwd. PER against 5-year mean PER 13.6x), we believe that the positives (strong orderbook replenishment prospects of the sector) have yet to be fully priced in. Hence, we advocate investors to selectively pick quality stocks that could ride on the expectations of news and contract flows this year. Our top pick remains IJM Corp (OP; TP: RM6.71) due to (i) it being a prime beneficiary of the soon-to-be awarded WCE project that will complement its other businesses, (ii) IJM Plant’s bright outlook driven by higher CPO price, and (iii) valuation still cheap vis-à-vis its historical average (fwd-PER of 12.1x against 5-year historical PER mean of 15.1x). We also continue to favour MUHIBBAH (OP; TP: RM3.00) and GADANG (NR) for the RAPID infra works. Meanwhile, CMSB (Not Rated), NAIM (OP; TP: RM4.15), and HSL (Not Rated) will still be favourite counters for the Sarawak growth story. Maintain OVERWEIGHT with our Outperform calls on BENALEC (TP: RM1.25), GAMUDA (TP: RM5.25), IJM (TP: RM6.71), MUHIBBAH (TP: RM3.00), NAIM (TP: RM4.15), TRC (TP: RM0.62), Market Perform calls on EVERSENDAI (TP: RM0.99), WCT (TP: RM2.50 and Underperform call on KIMLUN (TP: RM1.55).

Source: Kenanga