HSL’s 1HFY20 earnings of RM11.5m (-62% YoY) were slightly below ours and consensus expectations. Outstanding order book of RM2.1bn translates into a healthy 3.6x cover. Current operations are at 60% of pre-MCO operating capacity. Tender prospects remains backed by projects like the Sarawak Coastal Road, Second Trunk Road and Sabah Sarawak Link Road. Cut FY20-22 earnings forecast by 1-5%. Maintain HOLD with slightly lower TP of RM1.06 (from RM1.08) after earnings adjustment pegged to an unchanged 10x P/E multiple

Slightly below. HSL reported 2QFY20 results with revenue of RM83.1m (-26% QoQ, -53% YoY) and core earnings of RM4.0m (-25% QoQ, -46% YoY). This brings 1HFY20 earnings to RM11.5m, decreasing by 62%. The core earnings accounted for 33% of our and consensus full year forecast, which is slightly below expectations even after accounting for a post-MCO rebound in 2H.

Dividends. No dividends were declared in 1HFY20 (1HFY19: 1 sen).

QoQ/ YoY. QoQ and YoY core PATAMI declined by -48% and -76% mainly due to weaker PBT contributions from both construction (-56% QoQ, -80% YoY) and property (-27% QoQ, -65% YoY) segments in tandem with the revenue loss resulting from the MCO. According to management, the quarter captured construction productivity of roughly 40% at the beginning of the RMCO in June.

YTD. Core PATAMI declined by 62% in tandem with revenue decrease at both construction (-37%) and property (-55%) segments reflecting full period of the MCO.

Healthy orderbook. HSL’s latest outstanding orderbook stands largely unchanged at c.RM2.1bn, translating into healthy level of 3.6x cover of FY19 construction revenue. This year has been quiet on the awards front after securing RM663m worth of jobs last year. We attribute this to political and pandemic driven uncertainties. For FY20, we are pencilling in a lower RM150m as we enter the final 1/3rd of FY20.

Operational updates. Management guided that operations are gradually picking up with productivity at 60% of pre-MCO levels. Labour constraints have emerged as a key downside risk with acute shortages experienced in Sarawak resulting in upward pressure on wages. In our view, the government’s freeze on foreign workers has hindered replacement of returning workers and labour supply might not normalise quickly upon expiry of the freeze (31 Dec 2020). We think that 3-6 months may be required for adequate replenishment.

Outlook. HSL’s job prospects remain decent, buoyed by ongoing rollout of state projects like the Sarawak Coastal Road, Second Trunk Road and various rural roads. Jobs have seen slow progress due to political and pandemic factors. We reckon developments should accelerate running up to the polls next year. On the federal side, PN has reaffirmed its push for the Sabah-Sarawak link road (SSLR) whereby phase 1 (RM1.2-RM2b) stretching 90km connecting Lawas and Kampung Pa’Berunut is slated for rollout by end CY20. Overall, including phase 2 (335km), estimated total project costs would amount to RM5.2b with a construction period of 6-10 years. However, we note that phase 2 rollout may take time given that its completion timeline is scheduled for 2030. At present, execution for phase 1 of SSLR as well as PBH Sarawak remains the government’s utmost priority in Sarawak.

Forecast. We cut FY20/21/22 earnings by 1.4%/1.9%/4.7% after reducing replenishment assumptions to RM150m from RM300m due to slow award progress in FY20.

Maintain HOLD, TP: RM1.06. We maintain our HOLD rating with lower TP of RM1.06 (from RM1.08) after earnings forecast adjustment, pegged to an unchanged 10x PE multiple. 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) potential resurgence of Covid-19 cases (ii) possibility of further political uncertainty and (iii) labour constraints.

Source: Hong Leong Investment Bank Research - 7 Aug 2020