HSS Engineers’ 1Q18 result was disappointing. Core net profit grew 5% yoy to RM3.4m in 1Q18. Progress billings on its record-high order book of RM963m was slow as most of its major projects were at early stages of implementation. We expect better earnings starting from 2Q18 when it consolidates SMHB Engineering. Given concerns of a delay in the implementation of the recently secured RM273m Klang Valley MRT Line 3 (MRT3) and slower new contract procurement, we cut our EPS forecasts by 9-33% in FY18-20E. We maintain our BUY call with lower TP of RM1.44, based on target FY19E PER of 20x.

Dragged Down by Corporate Exercise Expenses

Net profit fell 72% yoy to RM0.9m in 1Q18, mainly due to one-off corporate exercise expenses of RM2.5m incurred for the acquisition of SMHB. Core net profit of RM3.4bn in 1Q18 was still below market and our expectations; comprising just 7-8% of consensus FY18 net profit forecast of RM41.5m and our previous estimate of RM46.2m.

Initial Stage of Implementation for Major Projects

Revenue increased 16% yoy to RM34m in 1Q18 with major contributions from major ongoing projects such as East Coast Rail Link (ECRL), KLSingapore High Speed Rail (HSR), Tun Razak Exchange External Roads and MRT2.

Cut Earnings Forecasts

We cut EPS by 33-34% in FY18-19E to reflect the potential delay in implementation of the MRT3 and ECRL projects and lower new contract assumption of RM150m for the rest of FY18, compared to RM250m previously. This is on the back of the new Pakatan Harapan’s plan to review the major infrastructure projects to be implemented. We only cut EPS by 9% in FY20E on expectations that implementation of these projects will accelerate and there is no cancellation of the projects.

Top Small-cap Construction Sector BUY

We believe HSS is in a position to weather the expected slowdown in new contract awards given its record-high order book and expand earnings base following the acquisition of SMHB. We cut our TP to RM1.44 from RM1.66 to reflect the EPS cut, which is partly offset by the roll forward of our target PER of 20x to FY19E. HSS remains our top sector small-cap BUY.

Source: Affin Hwang Research - 16 May 2018