KUALA LUMPUR: Construction stocks could have reached an upward inflection point, judging from the sector’s mini rally last week which coincided with announcements relating to mega projects light rail transit three (LRT3) and the Tun Razak Exchange (TRX).
UOB Kay Hian Malaysia Research said on Tuesday the sector’s valuation has been overly bearish with the market pricing in significant downward revisions of ongoing mega project contract values, and has probably re-rated merely on the government giving the go-ahead for some projects.
“Valuations should gradually price in option values for future mega projects. Maintain market weight on the sector,” it said.
The research house pointed out that before last week’s recovery, construction stocks were overly sold down by 25%-60% post the general election and most of the stocks are currently trading well below its fundamentally assessed trough valuations.
As valuations have turned overly bearish, it now appears that investors are drawing positive readings from last week’s announcements relating to the LRT3 and TRX.
It has been announced that these key mega projects will still proceed and contract beneficiaries with perceived links to the previous government will not be displaced.
To recap, last week the Ministry of Finance (MoF) announced that the LRT3 project is to proceed at a lower price tag of RM16.6bil (from RM31.6bil).
Additionally, TRX, through Lendlease, has dished out a new contract award to develop a mixed development project worth RM555mil to WCT.
“LRT3 scale down leads to adverse earnings impact. Based on our estimates, the company that will be hit the most in terms of contract works value is IJM Corporation; we assume its underground package value would be halved (to RM550mil), while its estimated earnings decline in FY18-19F would be at 1% and 5% respectively (due to low progress billings assumed in the initial stages).
“Meanwhile, other companies like Gabungan AQRS(GAQRS) and WCT would be affected from stations removal with expected earnings declines of 12% and 9% in FY18-19 for GAQRS 6% and 3% for WCT Holdings.
UOB Kay Hian Research said while values have emerged with the sell-off of most construction stocks post GE14, it viewed the government’s confirmation to proceed with mega projects like LRT3 as a positive sign in the construction sector, followed with momentous discussions on the East Coast Rail Link (ECRL) project which is expected to proceed subject to better terms.
Also, the market had thumped construction counters badly while ignoring sector positives which include: a) sustainability of strong earnings with orderbook cover of 2.1 times to 7.4 times (for stocks under its coverage); b) easing of raw material prices like cement prices which will improve overall margins; and c) likelihood of mega projects continuing.
“However, we have factored in a lower orderbook replenishment assumption (excluding job wins from mega projects like ECRL, MassRapid Transit Three and KL-Singapore High-Speed Rail) to factor in uncertainty in the sector’s outlook at the moment.
“We like contractors with clear catalysts (ie strong orderbooks, key beneficiaries of mega projects which are expected to continue, ie ECRL) such as GAQRS and Gamuda,” said UOB Kay Hian Research.
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