Investment Highlights

• We cut our FY21F net profit forecast by 24% while leaving our FY22–23F numbers relatively unchanged. We keep our fair value (FV) of RM0.92 based on 9x FY22F EPS, in line with our benchmark forward target PE of 9x for small-cap construction stocks. There is no FV adjustment for ESG based on a 3-star rating as appraised by us (Exhibit 4). Maintain HOLD.

• HSL’s 1HFY21 net profit came in below expectations at only 33% and 41% of our full-year forecast and the full-year consensus estimates respectively. We believe the variance against our forecast came largely from weaker-than-expected construction earnings due to sub-optimal productivity on various operational restrictions and challenges amidst a new wave of Covid-19 infections in Sarawak.

• Nonetheless, its 1HFY21 net profit rose 55% YoY as it began to adjust better to operating under the new norms. This was reflected in its 1HFY21 construction billings surging 42% while construction EBIT margin improved by 1.4 percentage points to 5.8%.

• Our earnings downgrade is to reflect a more prolonged and challenging path to normalisation of operations.

• Meanwhile, so far this year, HSL has only secured one key job, i.e. a RM130.7mil contract for the construction of the Leadership Training Institute for Sarawak Civil Service (Phase 1) in Kuching. We estimate that its outstanding order book currently stands at about RM1.7bil. No change to our forecasts that assume job wins of RM400mil annually in FY21–23F.

• We remain cautious on the local construction sector. On one hand, the trading sentiment on construction stocks may be buoyed by the impending announcement of the 12th Malaysia Plan and Budget 2022. On the other hand, macro and operational challenges remain aplenty in the sector including high national debt weighing on the government’s ability to roll out public projects in a major way. Mega projects have lost their shine (less impactful as they are not fast-tracked and implementation models that gravitate towards a public-private partnership where the main contractor may be required to take on certain operating/commercial risk and/or participate in the funding of the project). Also, competition is intense (amidst growing presence of foreign contractors especially large state-owned Chinese contractors) amidst higher operating cost and risk, lower efficiency and supply-chain disruptions as the pandemic rages on.

• In Sarawak, the implementation of much talked about RM11bil state reserves-fuelled infrastructure projects comprising the Coastal Road, Second Trunk Road and 11 mega bridges, has become less straight forward given that the 5-year term of the Sarawak legislative assembly already ended in June 2021, while a new state election is held back by the still raging pandemic.

• 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 as a small-cap construction outfit are fair at 10–ss14x forward earnings on muted growth prospects.

Source: AmInvest Research - 24 Sept 2021