Shining lights on FTSE-JSE

The construction sector has been the place to be this year after the run-up in the share prices of local construction companies.

The construction sector has been the place to be this year after the run-up in the share prices of local construction companies.

So far this year, construction company counters have gained between 70percent and 100percent, significantly outperforming every other JSE-listed share, not to mention the FTSE-JSE All Share Index, which was up 31percent to end-November.

For example, if you had bought Murray & Roberts at the beginning of the year, you would have benefited from a 93percent increase in the share, while Aveng is up 79percent, Group Five is 88percent higher and WBO has risen 65percent.

The question in the minds of many asset managers and investors is: will the sector experience the same or increased potential gains in the new year?

Feroz Basa, equity analyst at Old Mutual Asset Managers, says though he and many analysts thought these shares were already fully valued at the beginning of the year, they have seen them continue to rise steeply.

Basa was of the opinion that they were going to rise even higher, mostly on "sheer hype".

"Normally construction shares trade at around a 20 percent discount to the FTSE-JSE Industrial Index because of the risk associated with their large projects, but currently they are trading at premiums of 20 percent to 30percent. This illustrates how high the prices are on a historical basis," he said.

Basa said though these companies' medium- term earnings growth has been strongly underpinned by record order books, their current share prices imply that their big upcoming projects will proceed apace.

"There is no room for error. If one of these companies has even one large contract that somehow goes wrong, we could see a sharp reaction in its share price."

But Basa is hopeful that, depending on who wins major construction contracts early next year, including those for the construction of new World Cup soccer stadiums and King Shaka Airport in Durban, the share prices could rise even further.

But he cautioned investors to be alert and ready for a jittery 2007 and that a decision to sell would be difficult because local construction sector fundamentals have never been better.

"The sector is benefiting from a confluence in strong infrastructure spending by both the private sector and government, but the government spending is only just beginning," he said.

Though there has been some competition from Chinese companies, which have tendered about 25 percent cheaper than their local counterparts, Basa believes that most of these have not yet established their reputation in the market and are finding it difficult to compete on factors other than price.

"Another development . has been the exceptionally strong performance of the construction companies' materials businesses, supplying . materials for construction," Basa said.

Basa expects next year and 2008 to be the real "crunch time" for the local construction industry as many government mega-projects get under way ahead of 2010, as well as the construction of several new power stations costing R20billion each and development expenditure of R60billion by Transnet.