Investment Highlights

• We cut our FY19–21F net profit forecasts by 7% each, reduce our FV by 7% to RM0.99 (from RM1.07) based on 9x revised FY20F EPS, at a premium to our benchmark forward target P/E of 8x for small-cap construction stocks to reflect HSL’s niche strength in marine works/land reclamation. Maintain UNDERWEIGHT.

• HSL’s 1QFY19 net profit disappointed us and the market, coming in at only 22% and 21% of our full-year forecast and full-year consensus respectively. We believe the variance against our forecast came largely from weakerthan-expected construction margins realised. We have lowered our assumption for construction margins.

• 1QFY19 net profit only grew 2% YoY as stronger property profits were offset by lower construction earnings. Despite a 10% growth in its top line, construction EBIT fell 12% as EBIT margin contracted by 2.2ppts to 9%, which HSL attributed to “more projects secured via open tender and the general increase in cost of construction”.

• At present, HSL’s outstanding construction order book stands at RM2.5bil, 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). So far in FY19F, HSL has secured new contracts worth about RM376mil. Our forecasts assume job wins of RM400mil annually in FY19–21F.

• We maintain our view that a sustainable funding model for public infrastructure development in Sarawak is by tapping into federal funds vs. draining the state reserves of Sarawak. In any case, we believe the market could have adequately priced in the potential of a state reservesfuelled infrastructure boom in Sarawak (ahead of the Sarawak state election by Sep 2021) with HSL share price having held up at levels close to those prior to the 14th general election (GE14) in May 2018.
• Also, with the altered political landscape following the GE14, we could potentially see greater participation of Peninsular players in the construction market in Sarawak, resulting in increased competition and hence reduced margins. This is mitigated by Sarawak being HSL’s home turf and its niche strength in marine works/land reclamation. HSL’s valuations are unattractive at 12–14x forward earnings on a muted sector outlook.

Source: AmInvest Research - 23 May 2019