Investment Highlights

• We cut our FY18-20F earnings forecasts by 14%, 6% and 3% respectively, reduce our FV by 35% to RM1.30 (from RM2.00) and downgrade our call from BUY to HOLD for Hock Seng Lee (HSL).

• Our FV is based on 9x revised FY19 EPS to reflect a lower benchmark forward target PE of 7-9x for small-cap construction stocks. We previously regarded HSL as a mid-cap construction stock and valued it at 13x forward earnings.

• HSL’s 1QFY18 net profit missed expectations only 19% and 20% of our full-year forecast and full-year consensus estimates respectively. The variance against our forecast came largely from slower-than-expected progress billings from its key construction project, namely, Pan Borneo Highway.

• Nevertheless, 1QFY18 net profit still increased 24% YoY on the back of better progress billings from wastewater projects in Miri and Kuching coupled with higher property earnings.

• Meanwhile, HSL’s outstanding order book currently stands at RM2.5bil (Exhibit 2). It has yet to secure any project in FY18. We cut our FY18-20F order replenishment assumption to RM400mil annually (from RM600mil). In FY17, HSL secured RM655mil (inclusive property development of RM80mil) worth of new jobs.

• HSL will not be spared the weakened prospects of the construction sector, as the government puts under review various mega infrastructure projects on grounds of fiscal prudence. These projects could potentially be deferred, scaled down or even cancelled. Also, the introduction of a more transparent public procurement system to plug leakages will translate to lower margins for players.

• However, we take comfort in HSL’s substantial order backlog of that should keep it busy over the next 2-3 years, coupled with its core strength in marine works and land reclamation which enables it to stay relevant the construction market.

Source: AmInvest Research - 25 May 2018