KUALA LUMPUR (March 18): While sentiment on the construction sector is seen to have somewhat recovered, construction stocks are seen to be running ahead of its fundamentals, according to MIDF Amanah Investment Bank Bhd Research.

In a report today, MIDF Research's Muhammad Danial Abd Razak highlighted that further extension to the gains must be underpinned by commensurable growth in forward earnings, as sectorial price momentum has thus far outperformed the broader market.

"As of writing, we think the sector is still lacking solid catalysts which extend beyond the current visibility," said Muhammad Danial, downgrading the sector to "neutral" from "positive".

Going ahead, further gains must be driven by strength in earnings and prospects, said Danial, which he believes the sector players will remain beneficiaries of from existing projects, namely light rail transit line 3 (LRT3) and mass rapid transit line 2 (MRT2), and given its size of more than RM40 billion combined that is expected to support earnings in the immediate to medium term.

"We believe public projects comprising railways will continue to hold a significant share in the local industry, as potential roll-out of similar scale remains a possibility," said Muhammad Danial.

Nonetheless, Muhammad Danial suggested that near-term challenges will gravitate towards execution as he explained that the conversion from project delivery partner (PDP) to turnkey structure means contractors will need to bear the execution risk.

"Managing it well will likely translate to better margin, derived from the work progress completed," he said, adding that the extension period given for LRT3 should provide headroom for contractors to better allocate and spread out their resources.

He noted that upside risk to the sector could potentially be the revival of East Coast Rail Link (ECRL) project, should a meaningful portion be shared with local contractors.

Recall that previously local contractors could be allotted at least 30% of the civil works, as sub-contractors, worth about RM16.5 billion, he said.

Additionally, Muhammad Danial opined that the recent announcement on the takeover of Gamuda Bhd's toll highways is an added overhang factor, given that the company is a Bursa Malaysia Construction Index heavyweight.

For potential exposures, he suggested investors to take a closer look on companies with niche expertise and healthy balance sheet, namely Gabungan AQRS Bhd (BUY, target price (TP): RM1.87) and Muhibbah Engineering (M) Bhd (BUY, TP: RM3.15).

Notably, Muhammad Danial said seven out of eleven construction companies under the research house's coverage ended the year within and above the yearly estimates, with Muhibbah and KKB Engineering Bhd both posting results beyond expectations.

However, he downgraded Sunway Construction Group Bhd (+30.8% gain since January) and Gamuda (+29% gain since January) to neutral, from buy, as the previously beaten-down counters have recently risen close to their fair values.

Meanwhile, Muhammad Danial noted that the immediate prospect looks brighter in Sarawak as the state government has recently announced a record budget of RM9.1 billion for development.

Accordingly, the amount will be used to fund a few major infra projects including the Coastal Road, Second Trunk Road and the Water Grid Project.

"Following our optimistic view on Sarawak, we would recommend investors to consider Cahya Mata Sarawak Bhd (BUY, TP: RM4.13) and KKB Engineering (BUY, TP: RM1.33), which we opine to be the front-runner for the pending roll-out of the infrastructure projects aforementioned," said Muhammad Danial.