Period

3Q15/9M15

Actual vs. Expectations

9M15 core net profit (CNP) of RM54.5m came in below expectation, accounting for 68% and 66% of our and consensus’ expectations, respectively.

The negative variance is mainly attributable to higher-thanexpected construction costs coupled with higher recognition of lower margin projects.

Dividends

None, as expected.

Key Results Highlights

QoQ, 3Q15 revenue rose by 6% to RM158.4m, mainly attributable to increase in construction revenue by 7% on higher progressive billings. Correspondingly, 3Q15 CNP increased by 5% to RM17.9m, while its net profit margin remains flattish at 11%.

YoY, while 9M15 revenue surged by 20% to RM494.5m, CNP shrunk by 4% to RM54.5m. This is mainly due to lower margin jobs being executed, coupled with the increase in construction costs further bringing down the EBITDA margins for its construction division by 3ppt to 15%.

Outlook

The group updated that it currently has about RM770m worth of outstanding orderbook, which provide earnings visibility for at least a year.

Moving into 2016, we strongly believe that it will be a significant year for HSL, underpinned by the potential contract flows from several high-profile projects in Sarawak that is expected to be rolled out in 1H16. Among these projects are: (i) Phase 2 Kuching Centralised Wastewater System (RM700m), (ii) Pan-Borneo highway (RM27b), and (iii) various infrastructure projects (road and water) in the SCORE area (Samalaju, Mukah, Tg Manis). Being one of the prominent contractors in Sarawak with strong track records in infrastructure projects, we believe HSL is set to be one of the prime beneficiaries of these projects.

Change to Forecasts

We cut our FY15E-16E earnings by 10%-4%, after factoring in a lower gross profit margin assumptions (reduce 1-2ppt to 19%-18% for FY15E-16E) due to the hike in construction costs.

Rating

Maintain MARKET PERFORM

Valuation

Despite our downgrade in our FY15-16E earnings, we are reiterating our MARKET PERFORM call on HSL with a higher Target Price of RM2.03 (previously, RM1.79), as we upgraded our FY16E PER to 13x (from 11x), in anticipation of more contract newsflow arising from Sarawak plays in FY16, which neutralise the near-term earnings risks this year. We believe the valuation is justifiable, given that the group managed to achieve 14x Fwd PER valuation when the Pan Borneo news garnered investors’ interest in 2013.

HSL is one of the few contractors that are generating double digit margins in the construction space, while its current outstanding orderbook provides earnings visibility for the next one year.

Risks

Failure to meet new contracts assumption.

Higher-than-expected input costs.

Slower-than-expected construction works progress

Source: Kenanga Research - 27 Nov 2015