1H17 CNP of RM20.8m came in below our and consensus forecasts, accounting for 33% and 32% of estimates, respectively. Negative variation stemmed from: (i) Kuching Wastewater plant project timeline being pushed back, and (ii) lower-than-expected margins from Pan Borneo project. A 1.0 sen dividend was declared as expected. Downgrade FY17-18E earnings by 20-8%. Maintain MP with a lower TP of RM1.40.

Below expectations. 1H17 CNP of RM20.8m came in below our and consensus forecasts, accounting for 33% and 32% of estimates, respectively. We believe the negative deviation stemmed from: (i) Kuching Wastewater plant project timeline being pushed back as HSL was ironing out further details in relation to the on-site ground conditions with the client as highlighted in our Sarawak Study Visit Note (dated 18/8/2017), and (ii) lower-than-expected margins from Pan Borneo project. A 1.0 sen dividend was declared as expected.

Results Highlight. 1H17 CNP was down 26% YoY due to the decreased construction revenue (-17%) from lower work in progress given that their Kuching Wastewater plant project was pushed back by c.1 year due to on-site issue as explained above and the infancy stage of their Pan Borneo project whereby progress is c.10% and contributions is still not meaningful. 2Q17 CNP was down 16% QoQ due to the compression of construction PBT margins (-4ppt) which we believe stems from the higher proportion of billings from the lower margin Pan Borneo project.

YTD contracts surpass target. YTD, HSL has secured RM558m worth of construction jobs surpassing our FY17E replenishment target of RM400m. These new jobs comprise the Miri Wastewater project, a vocational facility (PPKS) in Mukah, a collector road in Samalaju and a school in Miri. Their outstanding order-book currently stands at RM2.6b providing the group visibility for the next 3 years. As for their property division, unbilled property sales at c.RM150.0m provide 2-3 year visibility.

FY17-18E earnings downgrade. Post result, we tweak our FY17E replenishment target higher to RM600m (from RM400m) given that YTD contracts have already surpassed our internal target. Despite the replenishment upgrade, we downgrade FY17-18E earnings by 20-8% to RM49.4-69m after: (i) pushing back the billings for the Kuching Wastewater plant project given that it has been postponed for a year vs. our initial expectations, and (ii) factoring for lower margins assumptions for Pan Borneo project.

Maintain our MP call with lower TP of RM1.40. Post earnings adjustment, we maintain our MP call but lower our TP to RM1.40 (from RM1.50) based on an unchanged FY18E PER of 11x. We believe our valuation for HSL of 11.0x is fair given that it is within our targeted PER range for small-mid cap contractors of 9-13x and their net margin of c.10% is fairly similar to peers’ average (KERJAYA, KIMLUN, MITRA).

Source: Kenanga Research - 23 Aug 2017