Investment Highlights

• We cut our FY18-20F net profit forecasts by 9%, 9% and 19% respectively and reduce our FV by 18% to RM1.02 (from RM1.25) based on 9x revised FY19 EPS. We value Hock Seng Lee (HSL) at a premium to our benchmark forward target P/E of 8x for small-cap construction stocks to reflect a less crowded construction market in East Malaysia vs. Peninsular Malaysia. Downgrade to UNDERWEIGHT from HOLD.

• HSL’s 9MFY18 net profit came in below expectations at only 67% of both our full-year forecast and full-year consensus estimates. We believe the variance against our forecast came largely from slower construction work progress at major projects coupled with lower margins realised. We have adjusted down these in our forecasts accordingly.

• 9MFY18 net profit grew by a third YoY thanks largely to stronger construction profits as key projects started to contribute more significantly, coupled with a slight improvement in property profits.

• At present, HSL’s outstanding construction order book stands at RM2.4bil, comprising largely remaining works for:
  1. the RM1.2bil work package for the Pan Borneo Highway (total value for the work package is RM1.7bil, HSL has a 70% share);
  2. the RM333mil Miri Wastewater Management System; and
  3. the RM563mil Kuching City Central Wastewater Management System (Phase 2) (total contract value is RM750mil, HSL has a 75% share).
  In terms of job wins, our forecasts assume RM250mil annually in FY18-20F. So far in FY18F, HSL has recorded RM157mil.

• We remain cautious on the outlook for the local construction sector. As the government scales back on public projects, local contractors will be competing for a shrinking pool of new jobs in the market. Severe undercutting among the players will result in razor-thin margins for the successful bidders. On the other hand, the introduction of a more transparent public procurement system under the new administration should weed out rent-seekers, paving the way toward healthier competition within the local construction sector.

Source: AmInvest Research - 29 Nov 2018