HSL’s 9MFY18 earnings of RM42m (+33% YoY) were below our expectations and consensus due to lower than expected construction progress billings. YTD core PATAMI increased due to higher contribution from construction segment. HSL’s orderbook of RM2.4bn (5.6x cover ratio) is at a healthy level. The company is currently bidding for work packages from Sarawak Coastal Road Project and Trunk Road project which are expected to cost c.RM11bn. Cut FY18-20 earnings by 9.2%, 9.0% and 9.6% respectively after impute slow construction progress billing. Maintain HOLD rating with higher TP of RM1.41 (from RM1.38) as earnings cut is offset by roll forward of valuation horizon to FY19. TP is derived by pegging 10x PE multiple to FY19 earnings.

Below expectations. HSL reported 3QFY18 results with revenue of RM173.3m (+12% QoQ, +37% YoY) and core earnings of RM14.3m (+1% QoQ, +29% YoY). This brings 9MFY18 core earnings to RM42.2m, increasing by 33% YoY. The core earnings accounted for 64% of our full year forecast (consensus: 67%) which is below expectations. The deviation was mainly due to lower than expected construction progress billings.

QoQ. Core PATAMI increased by 1% due to higher construction activities, partially offset by lower margin.

YoY. Core PATAMI of RM14.3m increased by 29% YoY mainly due to higher contribution from construction segment.

YTD. Core PATAMI of RM27.9m increased by 33% YoY mainly due to higher contribution from construction segment.

Orderbook level still healthy. HSL’s orderbook of RM2.4bn remains at a healthy level. This translates to a strong cover of 5.6x on FY17 construction revenue. We understand the company is currently bidding for work packages from Sarawak Coastal Road Project and Trunk Road project which are expected to cost c.RM11bn. Moreover, a total of 247 water related projects including water treatment plants, water piping upgrading works and wastewater management worth RM2.8bn is expected to be implemented over the next two years.

Sarawak the next place to be. Job flows in Peninsular Malaysia slowed down significantly following the change in Federal government. We understand that industry players are aiming for jobs in Sarawak as state government has allocated c.RM9bn for development expenditure under state budget 2019 which is the biggest in the history of the state. Funding for those projects is expected to come from Sarawak’s state reserves (c.RM31bn) which may insulate the projects from risk of reduction of federal government spending.

Forecast. Cut FY18-20 earnings by 9.2%, 9.0% and 9.6% respectively after imputing slow construction progress billing.

Maintain HOLD, TP: RM1.41. Despite the earnings cut, our TP is raised marginally from RM1.38 to RM1.41 given the roll forward of valuation horizon to FY19 at an unchanged 10x PE multiple. Although it has a record orderbook, we remain cautious on the slowing macro job flow outlook.

Source: Hong Leong Investment Bank Research - 30 Nov 2018