Construction sector entering an upcycle

KUALA LUMPUR: MIDF Research has maintained its positive stance on the construction sector with Muhibbah Engineering (target price: RM2.42) and Malaysian Resources Corp Bhd (target price: RM2.08) as its top picks.

“We reckon that the current higher risk-taking mode sweeping the market should be tracked closely and recommends taking long/short position of construction companies regardless of market capitalisation based on the balance of parity between price-to-book (P/B) and price-earnings (P/E) ratio for KL Construction Index,” the research house said in a report.

MIDF pointed out that the KL Construction Index (KLCON) had climbed to a new high of 25.43 times - its highest since its lowest PER of 5.8 times in 2011 alongside with recent lifting of share performance for index heavyweights such as IJM and Gamuda.

It added that the uptick illustrated a conformance to higher macroeconomic activity in the construction sectors such as higher total conventional project awards coupled with the total loans disbursed by financial institutions.

MIDF noted that for the period of 1QFY16 to 4QFY16, the total conventional projects awarded rose aggressively with CAGR of 68.3% driven by segments of residential, infrastructure and new projects awarded.

“Currently, we are experiencing its positive impact derived from the surge in construction loans disbursed. For example, in Jan-17 RM7.4bil loans disbursed was the highest since Jan-14 (RM7.4bn) combined with the aggressive rate of total conventional projects awarded hence the uptrend in KL Construction Index,” it said.

The construction sector receives constant loan disbursement rate for FY16 amounting to RM67.42bil (3.5% year-on-year) combined with 11,875 projects as opposed to Dec-15 amounting to RM65.13bil on the back of 11,583 projects.

“We observe that liquidity underpins the surge for residential, non-residential (buildings), infrastructure conventional construction segments and healthy construction trend in states such as Penang, Sabah, Sarawak, Selangor and Federal Territory,” it said.

Nonetheless, MIDF said the valuation of KLCON Index i.e. (P/E) and (P/B) ratios travelled further than expected. It noticed that sectoral earnings was set to increase due to liquidity flux to the construction sector which constantly remains between RM4.01bil to RM7bil.

“Consequently, enlarges the balance sheet of construction companies via lifting of non-current and current assets for example; receivables and short-term fundings.

“Secondly, liquidity fillips the current P/E ratio median of the KLCon Index to 25.56 times from its preceding period (March-16) of 16.2 times. Against the milieu of credit liquidity, we reckon that the median P/E ratio could go as high as 35.4 times. The prospect of 35.4 times P/E levels look undemanding if we compare to the rate of loans disbursed,” MIDF said.

The KLCon Index P/E and P/B ratios currently trades at almost parity which coincides with the sector’s highest P/B level on May-2010. Consequently, the sectoral P/E ratio fell in Jan-2011 to reach its lowest ebb in Jan-2012 in which continue to trade between the ranges of 5x-20x p/e ratio for the next 5 years (Dec-16).

“We believe that the valuation cycles of 2010-2011,is set to repeat. Due to the fillip of credit, earnings will expectedly expand and P/E ratio will ascend for the period of 2QFYE17 to 4QFYE17. Beyond that, it will probably normalise to reflect P/E ratio level which corresponds to P/B ratio lower than 1.0x. We deemed the Index’s movement as a consequent of liquidity impulse,” MIDF said.