Malaysia Construction: Could it be back in favor already?

· Back in favor already? Recent (5-day) out-performance, especially in WCT (16%) and Gamuda (19%) could suggest that the construction sector could very well be back in favor amongst investors. Following our recent sector note, (26th November 2008, Malaysia Construction - 2009 recovery story expected), we reiterate that it remains reasonable to expect the sector to recover in 2009, as a domestic pump-priming looks inevitable for the government to stimulate the economy. Again, we highlight the back-loading of the M$230B budget from the 9MP as an indicator of firepower for spending, since less than 50% has been spent cytd. We continue to bank on PM in-waiting Najib Razak to execute (and ideally, to accelerate) disbursements. If the M$7B stimulus package announced in November 2008 is an indicator of things to come, then it remains fairly reasonable to even expect a raise in the spending budget to boost domestic confidence, with an intention to generate the high multiplier effects.

· Certainly one to keep on the radar: Excessive risk aversion, coupled with thinning liquidity could deprive the contractors from immediate and absolute share price performance. As shown in the past, the share price performance of contractors are highly correlated to domestic spending, granted that the sector in the past has outperformed the benchmark index (38-51%) during "expansionary periods" and underperformed (15-20%) during "contractionary periods". The sector is currently trading at 8x PER, which is a -1 SD event (6-26x range from 2000), and the cheapest that it has been since the Asian Crisis (5x PER).

So the worst could be over: We believe immediate survivorship is now a function of earnings visibility, and the ability for the contractors to service their debt and working capital obligations. Although earnings could continue to deteriorate over the foreseeable quarters, share price recovery is not unreasonable, as we think that the sector could potentially be sprinkled with catalysts for upside surprises. Although the weak macro outlook has led to a sharp pull-back in real estate and infrastructure demand globally, we are hypothesizing that the pipeline of government spending, (e.g. as seen in US and China recently) will take more prominence, and keep the construction orderbooks alive.

· Within our coverage, we remain Overweight on WCT (Dec-09 SOTP PT M$2.90) given their ability to still secure niche projects in Abu Dhabi (not Dubai), coupled with undemanding valuations. The dividend yield angle for Gamuda (Neutral, SOTP PT M$2.20) is also appealing, but IJM (Neutral, SOTP PT M$3.80) is likely to be range-bound in the near-term, as construction earnings could continue to disappoint due to legacy projects, despite trading at c.50% discount to NTA. Project execution is a risk for all 3 companies.

· Source: J.P. Morgan estimates. Prices as of Dec 16.