Construction - Consolidating before the long-waited election

We are maintaining our NEUTRAL recommendation on the construction sector in 1Q13 period as we see heightened risk from the upcoming 13^th General Election. As expected, the 2013 budget announcement has few catalysts to excite the construction sector, at least for the medium term. Despite some positive mainstream news flows on projects like Gemas-JB EDTP, WCE highway, MRT line 2, High Speed  Railway (HSR) and RAPID, we doubt that their awards will be out before the elections. Our NEUTRAL recommendation is also premised on the assumption that the 13^th general election will be held somewhere between end-March to early-June 2013. We still prefer fundamentally strong contractors that have manageable balance sheets and sufficient capacities to counter the mundane period like GAMUDA (OP; TP: RM4.29) and WCT (OP; TP: RM3.17). We foresee that both these companies will likely be the winner in case of any rebound in appetite for the construction sector. For the smaller capitalisation contractors, we like BENALEC (OP; TP: RM1.71) as its EIA report and off-taker agreement for its Johor land project is likely to be finalised during the period. 

9M12 results within expectations. The big cap construction companies’ earnings came in within our expectations, although the smaller caps came in mainly below. However, MRCB results surprised us as it had recognized the EDL compensation in its earnings, contrary to the management’s guidance earlier. This was due to the certainty of the government taking over its EDL highway, although the negotiation phase is still ongoing on the pricing and other terms and conditions. The nderperformers were mainly due to the lag impact of the LRT revenue recognition due to the delays in the issuance of Development Orders (D.O) by the Selangor state government. Going forward, the contractors’ 1H13 earnings will be better QoQ and YoY essentially due to the pick-up in the MRT and LRT work-inprogress jobs. Our top pick for the sector is GAMUDA (OP; TP: RM4.29), underpinned by its sizeable order book size of RM4.8b and tender book of RM10.0b.    

What to expect in 1Q13?  In general, mid to small size contractors earnings  are expected to rebound on a QoQ and YoY basis due to the progress of the ongoing contracts, i.e. the LRT extension and MRT projects. However, the upcoming 13^th general election will likely dent the sentiment due to the election risk. At present, we noticed that the flows of contract award have started to slow down as we believe the government had opted for a status-quo stance before the election.              

Stay on the sideline. Nonetheless, it would still not be entirely negative for the construction sector in 1Q13 as we believe that fundamentally strong contractors like WCT (OP; TP: RM3.17) and GAMUDA (OP; TP: RM4.29) will likely be able to withstand the uncertainty of the election outcome via their ability to leverage on their ample capacity and strong balance sheet position. In addition, we see WCT and GAMUDA benefiting from the potential rebound in appetite for the construction sector postelection. Some of the contracts which are in the pipeline and could benefit the two are (1) Gemas-JB EDTP (RM8b), (2) RAPID earthwork (RM1b), MRT Line 2, TRX earthwork (RM1b), high-speed rail (HSR) project (c. RM25b) and Langat 2 (RM3.1b).         

Potential upgrade? We will closely monitor the performance of the construction sector in 1Q13 as the sector could be attractive for bargain hunting should share prices overreact towards the election period. We see that the sector is poised for a re-rating post-election as we believe that the government would be more decisive then on awarding projects to contractors. Thus, we believe that positive contract flows will only be seen after the election with more news on the MRT Line 2 and HSR progress, i.e. government assessment on its feasibility study, public viewing and the alignment. 

The pick for niche play.  2013 will be an exciting year for Benalec as it is likely to roll out its Tanjung Piai (3,485 acres) and Teluk Pengerang (1,760 acres) projects. To recap, Benalec has obtained the concession to reclaim and develop both lands from the Johor state government and is expected to wrap up its EIA report by 1HCY13. We understand that there are already a few oil majors (off-takers) interested.   

We are maintaining an overall NEUTRAL recommendation on construction sector and our Top Buys are GAMUDA (OP; TP RM: 4.29) and WCT (OP; TP RM: 3.17).

Source: Kenanga