Investment Highlights

• We maintain our forecasts but cut our fair value by 20% to RM0.90 based on 8x FY21F EPS (from RM1.13 based on 10x FY21F EPS). We now value Hock Seng Lee (HSL) in line with our benchmark forward target P/E of 8x for smallcap construction stocks. We hold the view that HSL’s premium valuations against its small-cap peers (based on its niche strength in marine works/land reclamation) is no longer tenable given the significant loss in its market value in recent months, rendering it less investable to large institutional funds. Maintain HOLD.
• HSL’s 9MFY20 net profit came in at only 61% and 68% of our full-year forecast and the full-year consensus estimates respectively. However, we consider the results within expectations as we expect a stronger 4Q as construction activities gradually normalise from the height of the Covid-19 pandemic in Mar/Apr 2020.
• Its 9MFY20 net profit plunged 50% YoY as the movement control order (MCO) hurt both construction activities (work suspension coupled with disruption to material supply chain) and property sales, especially in 2QFY20. Construction EBIT margin contracted by 3.4 percentage points to 5.0% as the unit continued to incur certain overheads despite construction activities coming to a complete halt at the height of the pandemic, coupled with additional costs in relation to Covid-19 prevention standard operating procedure thereafter.
• At present, we estimate that its outstanding construction order book stands at RM2bil. Our forecasts assume job wins to normalise to RM400mil annually in FY20–22F, after a bumper year in FY19 with job wins of about RM700mil. So far in FY20F, HSL has only secured RM101mil worth of new jobs.
• We remain cautious on the outlook for the construction sector. The government has very limited room for fiscal manoeuvre given the still elevated national debt and reduced petroleum revenues. In Sarawak, while the state could step in to fill the gap with the RM11bil state reservesfuelled infrastructure projects comprising the Coastal Road, Second Trunk Road and 11 mega bridges (ahead of the state election which must be held by Sep 2021), the rollout of work packages from these highly publicised projects seems to have hit a snag after the initial hype.
• For HSL, the uncertain sector outlook is partially mitigated by its competitiveness due to its niche strength in marine works/land reclamation. However, its valuations are fair at 8–15x forward earnings on muted growth prospects.

Source: AmInvest Research - 26 Nov 2020