[Click eStock] "Construction Sector Investment Opinion Neutral... Difficult to Ride Low PBR Stocks"

Korea Investment & Securities announced on the 5th that it maintains a neutral investment opinion on the construction sector. However, it emphasized the need to focus on construction companies with expected earnings growth and shareholder return policies. The top preferred construction company selected by Korea Investment & Securities is DL E&C, followed by Hyundai Engineering & Construction as the second choice.

Korea Investment & Securities explained that the reason for maintaining a neutral investment opinion on the construction sector is that although there is strong market preference for low price-to-book ratio (PBR) stocks, the upward trend in return on equity (ROE) cannot be guaranteed.

Researcher Kyungtae Kang of Korea Investment & Securities stated, "Due to the high earnings volatility characteristic of the construction industry, it is difficult for ROE to steadily increase. While increasing shareholder return tendencies would help, given the industry's high debt ratio and contingent liabilities, it is realistically difficult to establish and maintain a policy of returning cash to shareholders over the long term."

Amid this, the construction companies recommended for purchase were DL E&C and Hyundai Engineering & Construction. Researcher Kang explained, "The reason for focusing on construction companies with sound financial health that have established shareholder return policies is because they are rare. During the housing market downturn, they can raise ROE through profitability gained in the plant and civil engineering sectors, so earnings prospects are favorable, making it appropriate to buy at the current valuation."

The combined operating profit of five construction companies?DL E&C, Hyundai Engineering & Construction, Samsung Engineering, GS Engineering & Construction, and Daewoo Engineering & Construction?in the fourth quarter of last year was 387.3 billion KRW. This fell short of the combined consensus by 47.7%, and excluding Samsung Engineering, the shortfall widened to 78.3%. This was due to construction companies engaged in housing contracting either raising the estimated costs at housing sites, conducting rush work at sites nearing completion, or failing to conclude negotiations on increased contract construction costs.

Researcher Kang said, "In addition to the recurring cost ratio pressure every quarter like a refrain, there were also cases of bad debt write-offs of accounts receivable unlikely to be recovered from unsold units before and after completion (Daewoo Engineering & Construction)."

The problem is that there are no signs of a real estate market recovery this year either. Accordingly, a decline in housing sector sales this year also seems inevitable. Researcher Kang said, "The number of housing units sold (started) by four construction companies was only 46,701 units," adding, "This achieved about 70% of the plan set at the beginning of 2023."

Since the additional rise in the construction cost index after groundbreaking has stopped, the construction margin for sites started last year, which was carefully determined, is favorable. However, since achieving the groundbreaking target cannot be guaranteed, the housing cost ratio is expected to remain around 90% until 2025.