■ Reiterate Add, as we lift FY24-FY25F EPS forecasts and TP to RM1.21.

■ Near-term tenderbook at RM415m but we see potential projects of RM1.9bn for engineering services and project management in the next 2 years.

■ We think sustainable P/E re-rating would depend on rising recurring income for its fourth vertical and overseas projects to diversify concentration risks.

Reiterate Add; raise FY24-FY25F EPS and lift TP

We reiterate Add on HSS Engineers (HSS) with a higher DCF TP of RM1.21 (WACC: 9.4%, TG: 4.5%) as we lift our FY24-FY25F EPS by 5.1%/5.5% to factor in higher new project wins and margins. At our new TP, HSS will trade at 16.6x FY24F P/E, which is still below mean post-Covid-19. We like HSS as a capex light proxy for the front end of the construction value chain, given its highest revenue exposure and employee numbers in the local engineering and project management services (EPMS) sector. We estimate ROEs for CY23F at 11% vs. sector average of 6.8%. Downside risks are slower rollout of key infrastructure projects and single project risk as its MRT 3 Project Management Consultancy (PMC) contributes c.63% of its RM1.4bn order book as at 30 June 2023. 

What is 2024F looking like?

We came away from a recent meeting with management feeling more positive. YTD wins are at RM150m and it remains confident of achieving its RM300m full-year target. While officially its tenderbook is at RM415m (historically 50% success rate), we believe there is a potential RM1.9bn worth of EPMS projects in the pipeline locally over the next two years (Fig 5). The more impactful projects will be Pan Borneo Sabah Phase 1B, Penang LRT, Westports and industrial/data centres, in our view. While it is early days, we believe HSS is making the right strides in two areas which are crucial to ensure longer-term P/E expansion: i) recurring income wins for its 4th Vertical (Fig 9) with a 30MW solar photovoltaic plant in Kedah for the Corporate Green Power Programme (CGPP) which is also a positive milestone for ESG; and ii) more overseas projects with recent wins in Bangladesh and for Jakarta LRT. HSS’s lean balance sheet with a net gearing of 0.07x also enables it to be more aggressive in its expansion plans, in our view.

Earnings delivery on the mend with margin recovery

Since 2014, HSS’s orderbook has registered a 45% CAGR to a peak of RM1.4bn (Fig 6) where its largest project, MRT 3 PMC worth RM1bn is progressing well with 10% progress billings as at June 2023. This together with the engineering design division anchored its 1H23 results with core net profit increasing 74% yoy to RM11m. Gross margins over the last 6 quarters have averaged 33% (vs. FY20-FY21 average of 26%), driving its earnings turnaround. We expect a 2-year EPS CAGR of 31% over FY23-FY25F, driven by higher profit recognition for its MRT 3 PMC which will be more apparent once the three large civil engineering packages are awarded. We believe this will likely be by 4Q23F given the tender validity has been extended until 31 Dec 23.

Source: CGS-CIMB Research - 25 Sep 2023