Construction - Look Out for Delivery

We reiterate our NEUTRAL call on the sector due to: (i) slower contract award news flow for 2017, (ii) heightened earnings delivery risks due to delays in work progress/high building material cost, and (iii) toppish valuation with KLCON trading above its 5-year +2.0SD. Furthermore, we no longer have any OUTPERFORM calls for our core coverage as most are MARKET PERFORM with three UNDERPERFORMs (SENDAI, HSL, and WCT). Going forward, we advocate a sell-on-strength strategy on the sector in which we urge investors to take the opportunity in taking profit on any positive news flow that is expected in 2HCY17.

Strong interest in small-mid caps… At our report cut-off date of 23-June-2017, the average capital gains for the stocks under our coverage was 20.4% as compared to our 1QCY17 period that only saw an average capital gain of 6.8%, with the small-mid caps taking lead registering average gains of 27.7% over big-caps’ average gains of 9.4% on a QoQ basis. In our 2QCY17 performance review over 1QCY17, SENDAI garnered the strongest performance with positive gains of 126.4% followed by KERJAYA and SUNCON, which registered positive gains of 32.2% and 18.8%, respectively, while the rest registering gains of <10 18.7="" 2016="" 23-june-2017.="" 3.34="" 4.1="" 8.1="" 8.4="" and="" as="" back="" be="" believe="" br="" construction="" could="" coverages="" cut-off="" date="" delivery="" due="" earnings="" expectations.="" fail="" from="" gain="" gains="" have="" his="" hsl="" i="" ii="" in="" increased="" index="" interest="" investors="" kl="" klci="" koon="" like="" losing="" market="" mr.="" negative="" of="" only="" other="" our="" outperforms="" performance="" performances="" price="" primarily="" private="" reasons="" recovery="" registered="" report="" s="" sendai="" several="" share="" shareholdings="" steady="" stellar="" still="" stock="" strong="" such="" terms="" that="" the="" their="" to="" was="" we="" were="" which="" who="" year-to-date="" yet="" yew="" yin="">
1QCY17 results review. We started off 1QCY17 reporting season with better set of results released. Within our coverage universe, 11 construction stocks and 8 contractors came within to broadly within expectations, 1 above and 2 below. This is an improvement compared to 4Q16 when 5 stocks failed to meet our expectations. Notably the disappointments this round are Sarawak-based contractors like HSL and NAIM. For HSL, disappointment mainly stems from slower-than-expected billings from on-going projects, i.e. Pan Borneo and Kuching Waste Water, while NAIM’s disappointment is due to unexpected losses from Dayang.

YoY, bulk of the contractors registered CNP growth ranging from 2%-22% except for four contractors that saw declines in their CNP by 30-39%. The decline in the performance for these contractors, i.e. HSL, KIMLUN, MUHIBAH, SENDAI were mainly due to slow progress billings as bulk of their on-going project were still in their preliminary stage. QoQ wise, we have five contractors that registered decline of 4-343% in their CNPs due to similar reasons mentioned above. We note that NAIM saw its CNL widened by 343% as its associate Dayang sunk into the red this time around registering losses of RM13.0 vis-à-vis 4Q16 profit of RM14.0m; its continuous earnings disappointments have further reinforced our conviction in ceasing coverage on the stock.

Slow award flows as expected… As highlighted in our previous strategy report, we are anticipating slower contract flows at the range of RM25.0-30.0b for listed construction players in CY17 which came in within our expectations thus far given that we only saw RM13.9b worth of jobs clinched by listed players in 1HCY17, down by 62%, YoY. In terms of job flow expectations for 2HCY17, we are looking out for news flow from LRT3 (RM9.0b), Pan-Borneo Sabah (RM12.8b), and government housing jobs, while jobs from the private sector would be from projects like Bukit Bintang City Centre and new development launches with beneficiaries such as IJM, SUNCON, GAMUDA, AZRB, GADANG and KERJAYA. As for mega projects like East Coast Rail Line, we are still maintaining our view of contract award flows to materialise earliest by 4QCY17 or 1QCY18, and should the contract award be dished out earlier than expected it would be a re-rating catalyst for the sector and we believe that most contractors would benefit given the sheer size of the project. Names to look out for are GAMUDA, IJM, AZRB, GBGAQRS, and potentially GKENT. That said, contractors with strong piling capabilities like SUNCON, ECONBHD, PTARAS, and IKHMAS should also be in the limelight as news flow picks up pace in 2HCY17 and we are also expecting more contract news flow related to road works maintenance in 2HCY17 given that the government has allocated RM4.6b for state road maintenance. Coupled with the possibility of a general election just round the corner, beneficiaries to look out for are names like PRTASCO, CMS, and EDGENTA. However, at this stage, we believe we have built-in sufficient order-book replenishments in our estimates.

Delivery is the key! We strongly believe that given the slew of contracts won by contractors back in CY16 and 2HCY17, the main highlight for 2017 would be earnings delivery, as our major concern for contractors is their ability to deliver earnings in CY17, especially after they had enjoyed a good run backed by strong contract award flows, which have built in high expectations for the sector.

Valuations. At our report cut-off on 23-June-2017, KLCON index is trading at 16.4x which is at 5-year +2.0SD level, and we deem valuations to be fairly rich with big caps trading at 1-year forward average of 21.3x (IJM, GAMUDA, WCT, SUNCON) coupled with the lackluster earnings trajectory despite multiple contract wins in the past. Meanwhile, small-mid caps 1-year forward valuations average at 13.5x had risen from 11.2x as compared to 1QCY17 review period, charting a new high in valuation. We believe that the “re-rating” is largely driven by improved market sentiment, and with valuations at seemingly toppish levels, risk of share price corrections is high if there are disappointments in earnings delivery.

Maintain NEUTRAL. In view of potential slower contract flows throughout the year, higher execution risks, and coupled with valuations at 2-year high; we reiterate our NEUTRAL call on the sector. Furthermore, we no longer have any OUTPERFORM calls for our core coverage under the sector but three UNDERPERFORM calls, which are SENDAI, HSL, and WCT. Going forward, we advocate a sell-on-strength strategy on the sector in which we urge investors to take the opportunity in taking profit on any positive news flow that is expected in 2HCY17.

Source: Kenanga Research - 7 Jul 2017