Investment Highlights

• We initiate coverage on HIL Industries Bhd (HIL) with a HOLD recommendation and a target price of RM1.10 (theoretical ex-bonus target price: RM0.90). Although we like HIL for its impeccable track record in the plastic injection industry, strong pipeline of property developments projects and positive earnings growth in the next two-to-three years, we think HIL’s share price is fairly valued, having already priced-in the earnings growth expectations.

• Over the years, HIL’s plastic injection business has amassed a significant and well-diversified client portfolio ranging from the automotive, IT, as well as the consumer electronics sectors, with notable names like Perodua, Honda and Dell in its books. To meet the demand of its clients, the group has built three manufacturing plants, including its main facility located on a 7-ac. land in Shah Alam, Selangor. HIL has also rented a facility in Suzhou, China - offering services like mould making, injection molding, spray painting and sub-assemblies to its IT customers.

• Leveraging on the positive performance of its property projects: Kemuning Greenhills and Taman Kemuning Hijauan 2, which was completed last year, the group launched Kemuning Greenhills – Quadz, a 64-unit double-storey, cluster semi-detached development with a gross development value (GDV) of RM65.0 mln in 2016. Quadz was completed in August 2017 and registered about 60.0% take-up rate as at September 2017. Moving forward, the group is planning to launch the final phase of its double-storey terraced properties located next to Taman Kemuning Hijauan 2, within the vicinity of the Bukit Rimau Township.

• We opined that earnings could decline in 2017 (net profit: -41.2% Y.o.Y), as key development projects reach their completion stage. However, we expect HIL’s earnings to recover in 2018 (net profit +70.6% Y.o.Y), underpinned by improved performance of the manufacturing division as well as higher revenue and profit recognition from new development projects in Bukit Kemuning. We arrived at our target price on a sum-of-parts (SOP) approach, where we assigned a PER of 11.0x to its 2017 manufacturing earnings, while its property development segment is valued at 0.75x its RNAV, after accounting for the full conversion of its warrant.

Recommendation

We like HIL for its well-diversified clientele portfolio with customers from the automotive, IT, electrical and electronics, as well as industrial sectors to help it reduce its concentration risks and give the group opportunities to leverage on the positive growth momentum of its key clients such as Perusahaan Otomobil Kedua (Perodua), Honda Motor Co. Ltd. and Dell Inc. (Dell).

In addition to having an impeccable track record of over 40 years in the plastic injection landscape, HIL’s management is also headed by a team which includes A&M Realty Bhd Directors and Executives. With a solid background in the property development industry after undertaking various well established (landed and high-rise residential) projects like Amverton Hills and Amverton Kiara, we think that HIL will be able to withstand the vagaries of the real estate market and to ensure sustainable long term earnings.

We also like HIL for its strong balance sheet, which has been growing steadily over the years (average increase in its cash holding: 16.0%-22.0% from 2014-2016). With a net cash position of RM152.5 mln (excluding borrowings on hired purchase) at 31st December 2016, we believe that HIL has sufficient flexibility to finance future expansion plans and also for its landbanking activities.

Nevertheless, we think that HIL could be slightly affected by the lackluster property industry which has also impacted many other developers of late. However, we are positive that HIL’s upcoming residential projects will be adequately absorbed by homebuyers, driven by the: i) the project’s strategic location centered in the Klang Valley area, which is well connected to several major network of highways and vital amenities, ii) resilient domestic demand for affordable and landed residential properties, and iii) consistent marketing strategies by HIL to attract buyers.

We also like that HIL’s ability to command a higher-than-average EBITDA margin on its property projects, helped by its effective cost management strategies. In comparison to the bigger boys like IOI Properties Group Bhd, SP Setia Bhd and Sunway Bhd (average EBITDA margin: 16.0% - 34.0%) and the property sector average of 26.1%, HIL’s property unit was able to churn out more attractive margins, which ranged from 44.0% to 56.0% over the past three years. The above average margins will be beneficial to HIL as it will allow it to adequately cover the expected rises in construction cost.

Consequently, we expect HIL’s steady pipeline of upcoming launches and higher contribution from the manufacturing division, boosted by potentially higher orders from a key client, to sustain earnings visibility in 2018-2020. In all, we forecast a solid recovery in HIL’s earnings in 2018, driven mainly by: i) above average property margins in the property division, ii) more residential project launches in the pipeline, ii) robust balance sheet which will allow the group to pursue future landbanking activities, and iv) ability to leverage on the positive growth prospects of its key clients for its plastic injection business.

Investment Risk

Risks to our recommendations include the rising cost of raw materials like resin - a key ingredient used in HIL’s plastic injection process, which could adversely affect the group’s profitability.

Due to HIL’s labour intensive requirements in both the manufacturing and property development segment, rising labour costs and labour shortages could significantly disrupt the group’s day-to-day operations, creating ripple effects which could also result in thinner margins and reputational damage due to: i) higher overheads during factory underutilisation, ii) additional costs resulted from project delays or inability to fulfill production orders.

Being a major automobile parts supplier and property developer, HIL is also susceptible to the cyclical nature of the property and automotive industry, which are highly dependent on the economic health of the country. A slowdown in the economy (i.e.: slow wage growth and rising inflation) would weighed on consumer sentiment as consumers avoid purchasing big-ticket items like properties and new motor vehicles.

Other headwinds to HIL’s growth prospects include tighter property regulations and stringent mortgage lending policies by the government and/or the financial institutions, which would make it difficult for homebuyers to secure the necessary mortgage loans and curb home purchases. Failure to replenish HIL’s landbank could also potentially cripple its continuous stream of revenue after its current developments are completed.

Source: Mplus Research - 2 Oct 2017