We believe the outlook is positive for HSS to expand its current order book of RM558m over the next 12 months. Its current tender book is about RM300m, comprising bids for road, railway and water-related infrastructure projects. However, slower progress billings due to project delays and the slow roll-out of new government projects lead us to cut core 2019E EPS by 27%. Given HSS’ positive outlook, we lift our target 2020E PER to 26x from 24x and raise our target price (TP) to RM1.30 from RM1.25. We reiterate our BUY call with potential upside of 13%.

Good Prospects for New Contracts

We gather that HSS is bidding or negotiating for engineering contracts for the Johor Bus Rapid Transit (BRT), Non-Revenue Water (NRW) reduction plans and new water-related infrastructure for several states, Penang Light Rail Transit (LRT), Pan Borneo Highway (PBH) Sabah independent consultant engineer and additional design works for the East Coast Rail Link.

Expect Infrastructure Spending to Accelerate

We understand that the roll-outs of new public-sector projects have been slow in 1H19 and the environment remains challenging for most construction and engineering companies. We expect the government to accelerate infrastructure spending to support economic growth given the rising external risks of slower global economic growth and uncertainties on the US-China trade war. We believe HSS will be the first to benefit given requirements to appoint engineering consultants to design and conduct feasibility studies on infrastructure projects before they are implemented.

Earnings Cut

We cut our core EPS by 27% in 2019E as we reduce our new contract assumption to RM150m from RM200m. We trim our core EPS by 2-3% in 2020-21E on a lower EBIT margin of 17.2-18.6% (compared to 18.7-20.7% previously) due to competitive pressures for new government projects.

PER Expansion Justified

HSS historically trades at high PERs due to its strong domestic market position and scarcity premium as the only pure-play listed engineering firm in Malaysia during periods when the construction sector outlook is positive. On our updated estimates, the shares are trading at 2019E and 2020E PERs of 40x and 23x; the 12-month forward mean PER is 22x and 1SD above mean PER is 31x for HSS. Based on a 15% discount to the 1SD above mean PER, we derive our new target PER of 26x. We reiterate our BUY call with a TP of RM1.30 as we expect more positive news flow on contract awards.

Source: Affin Hwang Research - 2 Jul 2019