Period

2Q15/1H15

Actual vs. Expectations

1H15 core net profit (CNP) of RM36.7m came in below expectation, accounting for 39% and 40% of our and consensus’ expectation, respectively.

The negative variance is mainly attributable to higher-thanexpected construction costs and lower margins from higher exposure to open tender contracts.

Dividends

The company announced a first interim tax exempt dividend of 1.0 sen. For the full-year, we expect a total dividend of 4.0 sen, which translates into net dividend yield of 2.3%.

Key Results Highlights

QoQ, 2Q15 CNP fell 13% to RM17.0m, as revenue declined 20% to RM149.6m, due to completion of several major projects (wastewater management project) in 1Q15. Note that revenue from construction segment fell by 19% to RM144.0m, which is in line with prior year’s 2Q revenue.

YoY, despite its 1H15 revenue increasing 31% to RM336.1m, CNP rose marginally by 4% to RM36.7m. This is mainly due to lower EBIT margin (-6ppt to 32%), as they participated in more open tender projects that generally yield lower margins coupled with an increase in construction cost. We gather that the EBITDA margin for construction segment narrowed by 3ppt to 15%.

Outlook

The group updated that it currently has about RM860m worth of outstanding orderbook, which provide earnings visibility for at least two years.

In terms of job wins YTD, the group has secured RM210m of new jobs which accounts for 46.7% of our new contracts assumption of RM450m. This is in line with our expectation as we expect HSL to win most of the projects in 2H15.

We believe that from next year onwards, it could be significant for HSL as we understand that several high-profile projects in Sarawak are being rolled out. Among the projects are: (i) Phase 2 Kuching Centralised Wastewater System (RM700m), (ii) Panborneo highway (RM27b), and (iii) various infrastructure projects (road and water) in the SCORE area (Samalaju, Mukah, Tg Manis). Being a prominent contractor in Sarawak, we believe HSL could be one of the prime beneficiaries of these projects.

Change to Forecasts

We cut our FY15-16E earnings by 14-11% after trimming our gross profit margin estimates (-2ppt to 20%) and FY15 contracts assumption (-RM150m to RM450m) lower in order to recognise the hike in tendering and construction costs.

Rating

Downgrade to MARKET PERFORM (from OUTPERFORM)

Valuation

We adjusted our Target Price to RM1.79 (from RM2.18 previously), after lowering our FY16E PER to 11x (from 12x), which is in line with its small-mid cap peers’ range of 10-14x.

HSL’s fundamentals are still strong in terms of achieving one of the highest margins in the construction space while its current outstanding orderbook provides earnings visibility for the next two years. However, the group might encounter orderbook depletion issue should the new high-profile projects are not awarded to HSL next year. In view of the potential orderbook replenishment concern, we opt to be conservative by toning down our FY16E PER to 11x for now. Any reward of significant projects shall be a re-rating catalyst for the group and we will then revisit our recommendation.

Risks

Failure to meet new contracts assumption.

Higher-than-expected input costs.

Slower-than-expected construction works progress

Source: Kenanga Research - 27 Aug 2015