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Thursday, May 9, 2013

Construction sector rating upgraded after Barisan win in election


WE are upgrading the construction sector from “neutral” to “overweight” following our post-13th General Election (GE13) strategy report on May 6, 2012.

The sector upgrade is premised on three investment merits: clear order book replenishment visibility as the government will resume all the previous plans under the economic transformation programme (ETP) and Tenth Malaysia Plan (10MP); brighter earnings growth as the order book will continue to progress; risk premium no longer being valid as the GE13 outcome favours the contractors.

Hence, we expect the sector's valuation to revert to its fundamental value.

Our top picks for the sector are Gamuda (target price (TP): RM5.20),Malaysian Resources Corporation Bhd (MRCB) (TP: RM2.08) and TRC Synergy Bhd (TP: RM0.72).

So far, the construction stocks have reacted positively to Barisan Nasional winning 133 out of the total of 222 parliamentary seats. The KL Construction Index hit its 52-week high on Wednesday nd has gone up by 11% since earlier this week. Top gainers in the index included Gamuda (RM0.28), IJM Corp (RM0.13), and WCT Bhd (RM0.12).

This certainly tells us that investor confidence towards the sector has been regained as they are no longer imputing any risk premium, which is typically attached to political uncertainties.

It is rather obvious that with the GE13 outcome, we can expect a resumption of mega infrastructure projects under plans like the ETP and 10MP.

Earlier planned contracts will be awarded and while timing of awards are not clear, we do expect this to take place soon which provides a clear order book replenishment visibility for contractors.

The sector will be driven by positive news and contract flows, especially on public-friendly projects' rail-infrastructure (MRT Line 2 or 3, High-Speed Rail, Gemas-JB electrified double tracking (EDT), Klang Valley EDT).

Hence, we expect the construction sector to continue to register robust growth in the medium term of up to five years. We estimate that the listed contractors have a running order book of RM45bil or more.

With no changes to the incumbent government, we expect the progress of order book to run smoothly for the next three to four years at the very least, which won't provide us with brighter earnings visibility as delays in earnings will be reduced.

Valuation should converge with the sector's boom cycle.

The construction gross development product (GDP) swelled by a double-digit growth of 18.5% in 2012 and is estimated to grow by 11.1% in 2013, making these two years one of the first double-digit growth recorded since 2000.

Hence, we believe the construction stocks' valuation should revert to their five-year average levels from their trough valuations (more than 1-Std Dev below of 12x 14x for big cap and 5x 6x for small-mid cap).

So, we are now benchmarking large and small-mid cap construction stocks under our coverage against the sector's 10-year forward price-earnings ration (PER) mean of 16x 18x and 7x 9x, respectively, and have rolled-forward our valuation basis to FY14 estimate (E) earnings.

Hence, this resulted in a upgrade in our TPs, on average by +16%. While maintaing Bina Puri (TP RM0.40), Fajar Baru (TP RM0.51), MMC Corp (TP RM2.80) and WCT (TP RM2.43), we revised upwards our TP for Benalec (TP RM2.08), Eversendai (TP RM1.71), Gamuda (TP: RM5.20), IJM Corp (TP RM6.25), MRCB (TP RM2.08), Naim Holdings(TP RM3.70) and TRC Synergy (TP RM0.72).

That said, we prefer large cap construction stocks that have big exposure in the rail infrastructure projects such as Gamuda (TP: RM5.20) and MRCB (TP: RM2.08).

In the small-mid caps space, we prefer TRC Synergy (TP:RM0.72), due to its status as the only Peninsular contractor that is able to ride on the Sarawak's robust SCORE as it holds the UPK license.

As the government economic plans continue, we see a lot of opportunities emerging from contracts to be clinched by contractors in the foreseeable future (at least for the next five years).

These contracts will come from the remaining ETP and 10MP projects, which include infrastructure developments of railway, highways, water works and mixed development projects.

The government has so far shown great commitments in developing railway infrastructure.

It has committed billions of ringgit into building railways including double tracking, LRT extensions (RM7bil) and MRT1 (RM23bil).

Going forward, we understand the government will continue to expand and upgrade the country's railway tracks.

The projects, among others, are: MRT2 and MRT3 (combined worth about RM60bil), KL Singapore High Speed

Railway (RM30bil), Southern Double Track (Gemas JB) (RM8bil), KVDT upgrades (RM850mil), LRT3 extensions (RM5bil) and East Coast Region Railway (RM30bil). These could all amount to a total contract size of RM104bil.

At the same time, Malaysia is poised to expand the expressway. Just a few days after New Year of 2013, the West Coast Expressway Sdn Bhd (WCESB) (80:20 of IJM:Keuro) was appointed as a concessionaire of the RM6bil West Coast Expressway (WCE) from Banting- Taiping.

Ahmad Zaki Resources Bhd (AZRB) won the second circle highway of RM1.5bil Kuala Lumpur Outer Ring Road (KLORR) highway. Moving forward, there will be more highways to be built especially in the Klang Valley such as Kinrara-Damansara Expressway (Kidex) (RM2.5bil), SUKE Highway (RM2.5bil)and DASH Highway (RM2.5bil).

In addition, we also understand that the government has already approved to build the RM7bil of the Pan Borneo highway that will link Sabah to Sarawak.

It is widely reported that the water treatment plant will be built in Hulu Langat in Kuala Lumpur to complete the Pahang-Selangor Raw Water Transfer that is currently on-going a 65% completion (tunneling). The project is estimated to cost RM3.9bil.

To recap, there are the few mixed development projects that are already in the pipeline the Tun Razak Exchange (RM20bil) and KWASA's Rubber Research Institute land at Sungai Buloh (RM10bil).

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