Saturday, January 22

Construction sector enters upcycle as index reaches new high

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KUCHING: The construction sector is entering an upcycle, the research arm of MIDF Amanah Investment Bank Bhd (MIDF Research) observes, with the KL Construction Index (KLCon Index) having climbed to a new high of 25.43-fold.

According to MIDF Research, this is KLCon Index’s highest since its lowest price earnings ratio (PER) of 5.8-fold in 2011 alongside with recent lifting of share performance for index heavyweights such as IJM Corporation Bhd (IJM) and Gamuda Bhd (Gamuda).

“The uptick illustrates 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,” it said.

MIDF Research noted that for the period of the first quarter of financial year 2016 (1QFY16) to 4QFY16, the total conventional projects awarded rose aggressively with compound annual growth rate  (CAGR) of 68.3 per cent 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,” the research arm observed.

“For example, in January 2017 RM7.4 billion loans disbursed was the highest since January 2014 (RM7.4 billion) combined with the aggressive rate of total conventional projects awarded hence the uptrend in KLCon Index.”

MIDF Research highlighted that the construction sector is receiving constant loan disbursement rate for FY16 amounting to RM67.42 billion, combined with 11,875 projects, as opposed to December 2015 amounting to RM65.13 billion on the back of 11,583 projects.

The research arm observed 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.

“As a result, the valuation of KLCon Index i.e. price-to-earnings (p/e) and price-to-book (p/b) ratios travelled further than expected,” it said.

The research arm noticed that sectoral earnings is set to increase due to; liquidity flux to the construction sector which constantly remains between RM4.01 billion to RM7 billion.

MIDF Research pointed out that this consequently enlarged 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-fold from its preceeding period (March 2016) of 16.2-fold,” the research arm said.

Against the milieu of credit liquidity, MIDF Research reckoned that the median p/e ratio could go as high as 35.4-fold.

“The prospect of 35.4-fold p/e levels look undemanding if we compare to the rate of loans disbursed,” it added.

MIDF Research noted that the choice is no binary outcome – consdiering growth then sector still has room to grow due to fillip of loans that could potentially stimulate the Index’s p/e ratio to 35.4-fold.

The research arm further noted that based on the liquidity in the sector, even current p/b ratio of 1.3-fold looks arguably low compared to the liquidity which could encourage it to 1.8-fold p/b level.

“However, laws of gravity apply; between the period of May-2010 to September-2010, KL Construction Index p/b ratio went to 1.8-fold but went below one-fold p/b in May-2011.

“Currently, KLCon Index p/b is trading below one-fold p/b which looks undoubtedly appealing,” it said.

It has however added that to separate the wheat from the chaff, convergence of sectoral p/b and p/e ratios unmasks the dizzying height.

MIDF Research further highlighted that 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.

The research arm noted that consequently, the sectoral p/e ratio fell in January 2011 to reach its lowest ebb in January 2012 in which continue to trade between the ranges of five-fold to 20-fold p/e ratio for the next five years (December 2016).

MIDF Research believed that the valuation cycles of 2010 to 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 normalize to reflect p/e ratio level which corresponds to p/b ratio lower than one-fold,” the research arm said.

The research arm deemed the Index’s movement as a consequent of liquidity impulse.

Nonetheless, MIDF Research maintained its positive stance on the construction sector with Muhibbah Engineering (M) Bhd (Muhibbah) and Malaysian Resources Corporation Bhd (MRCB) 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 p/b and p/e ratio for KLCon Index,” it said.