Investment Highlights

• We maintain our FY19F net profit forecast but raise our FY20–21F projections by 3% each, and increase our FV by 3% to RM1.05 (from RM1.02) 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. However, we maintain our UNDERWEIGHT call.

• HSL’s 1HFY19 net profit met expectations at 51% and 47% of our full-year forecast and the full-year consensus estimates respectively.

• 1HFY19 net profit grew 9% YoY as stronger property profits more than offset lower construction earnings. Despite a 10% growth in its topline, construction EBIT fell 2% as EBIT margin contracted by 1.1ppts to 9.1% due to increased competition and the general rise in construction cost.

• Our FY20–21F earnings upgrade is largely to reflect HSL’s YTD construction job wins of RM605.5mil as disclosed in the results announcement. This has already surpassed our FY19F full-year assumption of RM500mil. We now assume job wins of RM650mil in FY19F, but keep our construction order book replenishment at RM400mil annually in FY20– 21F (as FY19F job wins include the lumpy RM299mil Batang Paloh bridge job in Mukah).

• 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;

3. the RM563mil Kuching City Central Wastewater Management System (Phase 2) (total contract value is RM750mil, HSL has a 75% share); and

4. the RM299mil Batang Paloh bridge job in Mukah (part of the Sarawak Coastal Road project).

• We maintain our view that a sustainable funding model for public infrastructure development in Sarawak is by tapping into federal funds vs. draining on the state reserves of Sarawak. In any case, we believe the market could have adequately priced in the potential of a state reserves-fueled 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 post-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 11-13x forward earnings on a muted sector outlook.

Source: AmInvest Research - 22 Aug 2019