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Kenanga maintains 'overweight' rating on construction

KUALA LUMPUR (June 2): Kenanga Research has maintained an "overweight" rating for the construction sector, as it believed the government would gradually pivot their focus onto economic recovery measures for the mid to long-term horizon.

In a research note, it is convinced the construction sector would be a key lever for the government to kick start the recovery and it is a matter of time before the sector would undergo a blanket re-rating.

"Therefore, we feel the timing is now right to start accumulating construction names in anticipation for a rally and reckon the rally will come somewhere in late August to November.

"This is likely after the weak second quarter (Q2) calendar year (CY) 2020 reporting season (Movement Control Order peak) is being flushed out and secondly, as the market begins to pivot their attention onto goodies from Budget 2021 and the 12th Malaysian Plan," it said.

The research bank noted that its study for the Bursa Malaysia Construction (KLCON) Index indicated the potential upside of 30% from current levels.

On the earnings front, it aggregately reduced financial year (FY)2020 estimate (E) earnings by 20% to cater for the MCO impact but lift FY2021E earnings by 4% on deferred works.

"We expect the upcoming 1QFY20 earnings to disappoint the market – but we see an opportunity to accumulate," said Kenanga.

Kenanga's pick on the sector was based that it would not be left out in a government's plan towards recovery and construction remains the most effective conduit for the government to unleash their fiscal stimulus which boasts high multiplier effect - given the huge supply chain, amongst others.

In order to avoid a downward spiral in the economy, the government should focus on expediting existing projects and fire up new projects.

This include Mass Rapid Transit (MRT) 3, Rapid Transit System (RTS), Pan Borneo Sabah and High Speed Rail (HSR).

Meanwhile, it said the mechanics behind the construction sector work in such a way that its share price rallies tend to precede news flow.

"With contract news flow still in its infancy stage, we find that 'buy on rumours, sell on news' fit to position ourselves into the sector now," said Kenanga.

While it believes the sector would imminently undergo a sector wide-re-rating, earnings delivery is paramount to keep the rally sustainable.

Hence, it prefers companies which have the execution track record to effectively turn order-book into earnings.

"That said, we acknowledge that the Malaysian construction space is a cyclical sector at the end of the day and with companies having order-book of quantum in the billions, it is just unsustainable to achieve continuous order-book growth to support earnings.

"Thus, the rally will eventually taper off. Case in point, KLCON Index has been range-bound for the last two decades," it added.

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