The construction sector has underperformed KOSPI by 14.7% over the pastthree months: This was due to: 1) slowing overseas new orders in 1H due to a weakoil price, 2) disappointing 1H earnings because of margin deterioration and additionalloss from overseas by cost overrun, and 3) growing concern about a slowing housingmarket after the government’s property measures, announced on 2 August.    Korea E&C’s new orders in 1H17 fell 7.5% y-o-y. Despite relatively strongdomestic new orders, overseas new orders were weak. There was growing optimismthat delayed overseas new orders from UAE POC (USD2.5bn), Bahrain BAPCO(USD5bn) and Oman Duqm projects would resume in 1H 2017. However, only theOman Duqm project materialised. We think projects have been delayed further as oilprices have stayed below USD50 per barrel, compelling oil producing countries todelay placing orders because they are worried about deteriorated project profitability,as well as lacking the resources for construction cost.    Government announced severe property measures on 2 August, targetingproperty market speculation. Multiple home owners (three or more) will have to payhigher taxes on capital gains and face restrictions on getting mortgages. MaximumLTV (loan to value) has been cut from 60% to 40% in speculative areas, and to 30%for multiple home owners. Surging property price seem to be stabilising, especially inreconstruction and redevelopment apartments. However, transaction volume cliff isinevitable, in our view, and lack of housing supply may cause a further surge inproperty prices. What worries us is that domestic construction companies areaggressively bidding for reconstruction projects by significantly lowering prices. Thismay mean they win projects but margins will deteriorate, leading to projects beingloss making, as we have seen in overseas projects. According to local press reports(Yonhap News, 14 September), Hyundai E&C and GS E&C are competing to winBanpo #1 phase projects. Hyundai E&C even offered a special package (KRW70mper house) to Banpo #1 phase of home owner association to cover movingexpenses.    Our view on the Korea E&C sector is conservative. We have Buy ratings onHyundai Development (012630 KS, KRW35,450) and Daelim Industrial (000210 KS,KRW81,200): they have well diversified business portfolios and, while Hyundai Dev isdedicated to housing construction, it has diversified into other businesses such asduty free stores, the building maintenance business and the chemical industry. Ourleast preferred stock in the sector is Samsung Engineering (028050 KS, KRW10,200)and we rate it Reduce.

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