HSS reported a surprise net loss of RM2.8m in 2Q19 due to higher depreciation/amortisation and operating profit margin squeeze. Revenue fell 19% yoy in 1H19 due to the reduction in MRT2 contract value and ECRL contract suspension was only lifted in 3Q19. We expect a return to profitability in 2H19 as progress billings accelerate on its remaining order book of RM505m. We cut our core EPS by 47% in 2019E and 5-9% in 2020-21E to reflect slower new contract wins and progress billings, and higher depreciation/amortisation. We reiterate our BUY call with a reduced target price (TP) of RM1.18, based on 2020E PER of 26x.

Surprise Loss

The 2Q19 loss pushed HSS into the red for 1H19, reporting a net loss of RM2.5m. The losses indicate that market consensus 2019 net profit forecast of 17.8m and our previous estimate of RM14.2m are unlikely to be achievable. We were surprised by the high depreciation expense of RM2.3m in 1H19 following the adoption of MFRS16 accounting standard on Leases, low gross profit margin of 23.5% in 1H19 and lower-than-expected revenue.

Delay in New Contract Wins

Revenue fell 19% yoy to RM72m in 1H19 following the reduction in contract value for the Klang Valley MRT Line 2 (MRT2) contract and the suspension of the East Coast Rail Link (ECRL) design contract, which was only lifted July 2019 with additional works worth RM5m. Slow new contract wins led to its remaining order book declining by 8% to RM505m as at 30 June 2019 from RM546m as at 31 December 2019. We expect new contract wins in 4Q19 to expand its order book as HSS is bidding for the Johor BRT and water-related infrastructure projects. HSS is also bidding for the Large-Scale Solar 3 projects that engineering income and generate recurring earnings in the long run.

Positive Long-term Prospects

We believe HSS’ share price will likely consolidate at current levels in the short term following the 20% correction over the past month. We remain position on its long-term prospects to win new contracts as the government accelerates infrastructure spending. HSS tend to get the first bite of the cherry due to its strong track record in providing engineering services for the railway and water projects. Following the cut in 2020E core EPS while maintaining our target PER of 26x, we reduce our TP to RM1.18 from RM1.30 previously. Maintain our BUY call. Key downside risks are delays in winning new contracts and execution risks.

Source: Affin Hwang Research - 16 Aug 2019