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South Africa Builders Richest Since ‘08 Seen Extending Gains

South African President Jacob Zuma
South African President Jacob Zuma. Photographer: Dan Kitwood/Pool via Bloomberg

South African construction stocks, trading at their most expensive levels in more than three years, are poised to keep rising on government infrastructure spending, according to RMB Morgan Stanley and Avior Research Ltd.

The 10-member FTSE/JSE Africa Construction & Building Materials index, which sank 26 percent last year, has climbed 18 percent in 2012, outpacing a 7 percent rise on the FTSE/JSE Africa All Share Index. The construction index trades at 13.5 times forecast earnings compared with 11.6 for South Africa’s benchmark measure, the biggest premium since November 2008.

President Jacob Zuma unveiled plans in his Feb. 9 state-of-the-nation speech for a “massive” infrastructure drive help spur investment and support growth in the continent’s biggest economy. RMB Morgan Stanley raised Murray & Roberts Holdings Ltd., South Africa’s second-biggest construction company by market value, to overweight, the equivalent of buy, from equal-weight on Feb. 16, while Avior has buy recommendations on Aveng Ltd., Wilson Bayly Holmes-Ovcon Ltd. and Group Five Ltd.

“We’ve got a lot more bullish on construction this year; we think that at some point the negative sentiment probably shifts toward more of a focus on infrastructure build again,” Chris Meyer, chief executive officer of RMB Morgan Stanley, said in a Mar. 13 interview. “Government is under pressure for delivery to create jobs. We think even a small change in that sentiment will improve things.”

Australian Market

The Treasury allocated 844.5 billion rand ($112 billion) to telecommunications, energy, transportation, housing and water projects in the three years through March 2015.

Resources projects in Australia are providing opportunities for South African construction companies with operations in that country, Dirk Noeth, an analyst at Avior, said by phone from Cape Town.

“The Australian market is forecast to grow revenue between 10 percent and 12 percent over the next couple of years,” Noeth said. “That is still a growing market, where you are seeing it happen now; the South African market is not there yet.”

While Avior has a buy recommendation on Johannesburg-based Aveng, South Africa’s largest construction group, the brokerage is reviewing the rating following half-year results yesterday, Noeth said.

Under Pressure

Aveng fell 0.5 percent to 37.95 rand at the close in Johannesburg after gaining 2.5 percent yesterday. The group said its two-year order book jumped 24 percent to 46 billion rand as sales contracts at its Australian division increased amid rising demand from mining and energy companies. About 77 percent of the order book is from work outside of South Africa.

Fiscal first-half profit dropped 34 percent because of unresolved claims at two of the country’s coal-fired power plants, the company said yesterday.

This sector will remain under pressure for “at least the next 18 months,” Chief Executive Officer Roger Jardine said in a phone interview.

The expected margin of the company’s order book is 4 percent to 5 percent and should start showing signs of improving in the next 12 to 18 months, Jardine said.

“New projects are coming onto the books at fairly tight margins, or in some cases no margin; often it makes sense to take on jobs even if you aren’t making money,” Mark Ingham, director at Ingham Analytics, said by phone from Johannesburg. “Yes, we are in an up cycle, but I think the cycle will be more anemic than it has been in the past.”

‘Risk Versus Reward’

Noeth recommends clients sell Murray & Roberts, following a downgrade of the stock from buy on Mar. 12.

“It’s a risk versus reward play at the moment; the other plays in the sector offer similar upside for a bit less risk,” Noeth said. “There’s still some upside to the sector, albeit less than before.”

RMB Morgan Stanley raised its rating on Murray & Roberts after the Johannesburg-based company said it will sell 2 billion rand ($264 million) of stock to cut debt and fund expansion. A strengthened balance sheet will “ease the problems that have weighed on the company” analyst Roy Campbell wrote in a report.

“With a stronger financial position and commodity earnings support, risk-reward becomes more appealing, and we see potential for the stock to re-rate,” Campbell said.

Murray & Roberts dropped 1.3 percent to 29.85 rand, pairing its gains this year to 16 percent.

Johannesburg’s construction stock index was the worst performer among 31 industry groups on the bourse last year. This year the measure is the ninth-best performer with an increase of 18 percent.

While it may be too soon to expect a recovery for the construction sector, “when everything else has run, construction is probably a cyclical laggard,” Meyer said. “If everyone wants to buy some kind of cyclical upside as everything improves, the construction sector is the one that really hasn’t done much.”

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