HSL’s 1QFY20 earnings of RM7.6m (-25% QoQ, -46% YoY) were below ours and consensus expectations due to slower-than-expected construction progress billings. Outstanding order book of RM2.2bn translates into a healthy 3.7x cover. Current operations are at 30-40% of pre-MCO operating capacity. Tender prospects remains aided by state funded projects like the Sarawak Coastal Road Network as well as Second Trunk Road Project. Cut FY20-21 earnings forecast by 2-18%. Maintain HOLD with slightly lower TP of RM1.08 (from RM1.11) after earnings adjustment pegged to an unchanged 10x P/E multiple.

Below expectations. HSL reported 1QFY20 results with revenue of RM112.4m (- 40% QoQ, -23% YoY) and core earnings of RM7.6m (-25% QoQ, -46% YoY). The core earnings accounted for 18% of our full year forecast (consensus: 11%) falling below expectations.

Deviations. The results shortfall was due to slower construction progress billings as well as lower recognition of property sales respectively.

Dividends. No dividends were declared for the quarter (1QFY19: nil).

QoQ/ YoY. QoQ and YoY core PATAMI declined by 25% and 46% mainly due to weaker PBT contributions from both construction (-66% QoQ, -45% YoY) and property (-41% QoQ, -50% YoY) segments as a result of the MCO.

Orderbook. HSL’s latest outstanding orderbook stands at c.RM2.2bn, translating into healthy level of 3.7x cover of FY19 construction revenue. For FY20 we have pencilled in RM300m in job awards as we anticipated delays in award conversion this year (against RM663m secured in FY19).

MCO updates. HSL has restarted operations in June with its current pace at 30-40% of pre-MCO operating capacity. Management expects thinner margins going forward as a result of strict SOP compliance. Labour shortage was also highlighted as a challenge, we think potentially due to geography and Covid-19 screening bottleneck.

Outlook. Job awards have been dry so far as the Covid-19 pandemic and political fiasco significantly delayed contract award progress. Nonetheless, going forward, HSL’s jobs prospects remains aided by state funded projects like the Sarawak Coastal Road Network as well as Second Trunk Road Project. Gearing up to the state elections in 2021, we expect the rollout of such projects to accelerate where funding is covered by the state’s ample reserves. We understand the slower than anticipated project rollout pre-Covid-19 may have been due to the state’s intent on preserving existing reserves. However, we reckon the rapid deterioration in economic fundamentals brought upon by the pandemic would necessitate a faster rolling out of state projects as well as possible flow of new federal projects driven by potential pump priming measures.

Forecast. Cut FY20-21 earnings by 18.2% and 2.7% respectively after recalibrating earnings assumptions to account for the MCO and assuming a more gradual margin normalisation. Introduce FY22 earnings of RM65.1m.

Maintain HOLD, TP: RM1.08. We maintain our HOLD rating with lower TP of RM1.08 (from RM1.11) after earnings forecast adjustment, pegged to an unchanged 10x PE multiple in-line with trading multiples of smaller contractors. Our TP is derived based on FY21 EPS as it better reflects the sustainable earnings for the company. While we see HSL as a beneficiary of Sarawak’s robust infrastructure spending, this positive is offset by (i) slow award conversion and (ii) re-emergence of political uncertainty.

Source: Hong Leong Investment Bank Research - 19 Jun 2020