Facing Challenges

HSS Engineers faces the risk that its East Coast Rail Link (ECRL) contracts worth RM130.4m will be suspended or cancelled. It was reported that construction works for the ECRL will be suspended as the government would like the cost to be reduced. We cut our EPS forecasts by 4-26% for FY18-20E to reflect the potential cancellation of the ECRL contracts and lower new contract wins. We maintain our BUY call on undemanding valuations following the sharp share price correction. But reduce our TP to RM0.78 based on FY19E PER of 16x.

Stop Work Order

The Edge Financial Daily reported that state-owned Malaysian Rail Link Sdn Bhd, the ECRL project owner, has ordered the main contractor China Communications Construction Co. Ltd (CCCC) to suspend all works on the ECRL due to national interest reasons. The current Minister of Finance would like CCCC to reduce the cost of the project, which will balloon from RM55bn to RM81bn based on the previous government’s plan to extend the line to Port Klang, Selangor, and Pengkalen Kubor, Kelantan, and expand the line to a double track. We gather that the cost could be reduced to about RM40bn assuming the line only runs from Gombak, Kuala Lumpur, to Kota Bahru, Kelantan, with a single track.

Slow New Contract Procurement

The current review of large-scale projects will delay the award of new contracts over the next 6-12 months. We believe it will be challenging for HSS to secure new contracts in FY18. We cut our FY18/19/20E new contract assumptions to RM1m/RM150m/RM250m from RM94m/RM200m/ RM350m previously. We also remove earnings contribution from the RM104m remaining contract value for the ECRL, given the potential suspension of works, in our new FY18-20E EPS forecasts. This leads to a cut in EPS by 4-26% in FY18-20E.

Undemanding Valuations

Even after the cut in our EPS forecasts, we believe current FY19E PER of 13x is undemanding following the sharp share price correction. We reiterate our BUY call with TP reduced to RM0.78 from RM1.44 previously. We reduce the target FY19E PER assumption to 12-forward mean PER of 16x from 20x previously in view of weaker order book replenishment prospects.

Potential Projects in the Pipeline

The potential cancellation/suspension of the ECRL projects will reduce HSS order book by 19% to about RM542m, equivalent to 3.7x FY17 revenue. HSS remains optimistic that the RM8bn Penang LRT project will proceed and provide the opportunity for HSS to win detailed design and construction management contracts. Its competitive advantage is completing the feasibility studies for the project earlier. The government expects negotiations to acquire water concessionaire Splash and restructuring of the Selangor water supply sector to conclude next month. This would allow capital expenditure to expand the water supply and reduce water loss by replacing old pipes. The completion of the acquisition of SMHB Engineering will allow the group to bid for water-related contracts likely to be rolled out next year after resolving the stalemate in Splash acquisition talks.

Key Downside Risks to Our Call

Key risks to our BUY call would be: (1) M&A execution risks; (2) higher financing costs; (3) earnings lag due to the timing of contract wins; (4) execution risks involved in its expansion plans; and (5) a slowdown in the award of construction contracts.

Source: Affin Hwang Research - 5 Jul 2018