We initiate coverage on Hock Seng Lee (HSL) with an OUTPERFORM rating and Target Price (TP) of RM2.31. We derived our TP after applying fwd-PER of 11x on FY15 EPS, which is +1SD above of its historical fwd-PER mean. The valuation is also in line with mid-cap contractors’ average fwd-PER of 11x-12x. We like HSL as (i) it is one of the biggest contractors in Sarawak majoring in marine-engineering, (ii) it has consistently secured more than RM500m worth of jobs per annum since 2012 thanks to its market leader status coupled with the vibrant Sarawak growth story, (iii) it has bright earnings visibility driven by outstanding orderbook of RM1.1b and expected new orders of RM600m every year, and (iv) it has strong financials i.e. amongst the highest margins in construction space and strong cash pile (32 sen/share) with no borrowings. As mentioned in our thematic Sarawak visit report last year (dated 24 October 2013), we reaffirm our view that HSL is one of the major beneficiaries of the sustained development of infrastructure projects in Sarawak.

Major player in Sarawak. In terms of market capitalization, Hock Seng Lee is the biggest listed contractor in Sarawak. It is also the biggest marine-related contractor in the state. HSL’s main expertise is not just marine engineering; it is also involved in other construction projects such as roads, airports, ports, and buildings. This has made HSL a major construction player in Sarawak. It has expertise in three important segments of construction space, including building, infrastructure (waterrelated, bridges, highways) and basic amenities (roads, school, hospitals). Currently, its orderbook stands at about RM1.1b and which would last for the next 2-3 years.

Having a presence all over Sarawak and SCORE areas thanks to its flexibility and resources. Being a major contractor in Sarawak, HSL is everywhere in the state. More importantly, it has “significant” presence in SCORE areas (i.e. Samalaju, Mukah, Tg Manis). Its total orderbook currently stands at RM1.1b, of which 30% within the SCORE region.

Tanjung Manis main contractor. Interestingly, in Tanjung Manis, the owner and developer of the project, Sarawak Timber Industry Development Corporation (STIDC) holds HSL in high regards as a capable contractor. In fact, HSL has done a lot jobs in the Tanjung Manis. The most recent project in Tg Manis secured by HSL is the pump station for the water treatment plant.

Phase 2 Kuching Wastewater treatment plant to be secured soon? HSL is currently in the midst of completing the RM452m Kuching Centralised Wastewater System which it is currently testing and commissioning the system. It is now eyeing for the Phase 2 of the project, which the management guided it is worth between RM500m–RM1.0b. It is highly likely that HSL will win the project due to its expertise, resources, capacity, and track record. Timing-wise, we think the earliest that the Government will announce the project would be in 2Q14.

Strong financials - Superior margins, net cash and decent yields. HSL has a very clean balance sheet with no borrowings and net cash balance of RM179.0m (32 sen/share). Profitability-wise, HSL is one of the highest margin achievers among all contractors in Malaysia, thanks to its resources and ability to undertake highly complex engineering jobs that give better margin. In addition, the Group is also able to save costs by owning marine and land-based heavy equipment, including dredgers, tugboats, barges, cranes, and tunnel boring machines instead of subcontracting out such hardwares requirements to third parties. Moreover, HSL has been very generous in paying dividends of 3-4 sen since three years ago thanks to its positive cash flows. This translates into dividend yields of 2%-3.2%, which is comparable to the construction sector yield.

Source: Kenanga