FY18 CNP of RM53.8m came below our/consensus forecasts accounting for 88/92% of estimates respectively. A 1.4 sen dividend was declared in 4Q18, bringing FY18 dividend to 2.4 sen, slightly above our assumption of 2.2 sen. Trim FY19E estimates by 4% and introduce FY20E earnings of RM72.8m. Maintain UNDERPERFORM with a lower Target Price of RM1.25 (from RM1.30) based on FY19E PER of 10.0x.

Below expectations. FY18 CNP of RM53.8m came below our/consensus estimates at 88%/92% stemming from lower-than- expected margins due to: (i) project mix with higher composition of lower margin open-tender projects and (ii) higher cost of construction from the minimum wage hikes and higher commodity prices. A 1.4 sen dividend was declared in 4Q18, bringing FY18 dividend to 2.4 sen, slightly above our assumption of 2.2 sen.

Results highlight. YoY, despite a strong revenue growth of 45% driven by its construction division, FY18 CNP of RM53.8m grew 13% mainly due to margin compression from its construction division. Construction revenue grew by 53% as the construction progress for its major on-going projects picked up pace while pre-tax profit for construction division only grew 13% due to higher costs from general increase in construction cost (i.e. minimum wage hike, higher raw material prices) and higher billings from open tender projects, which generally see lower margin. Its property revenue grew 10% while pre- tax profit for its property division registered 14% growth due to improvement in margin (+1ppt) backed by sales of its on-going projects like La Promenade and VP Industrial Park. QoQ, 4Q18 CNP saw a 20% fall as revenue declined 13%. The decline is due to slower-than- expected construction billings which we believe is due to particularly high rainfall in East Malaysia and exacerbated by margin compression (-2ppt), due to higher construction costs and project mix with higher composition of lower margin projects.

Progressing smoothly. Despite slower progress billing in 4Q18, we believe that the overall construction progress for its existing projects like Pan Borneo, Miri and Kuching Waste Water are progressing smoothly at c.40%. As such, we anticipate higher construction billings in FY19 as its major on-going projects move into more mature stages. On the other hand, we understand that HSL is still in the process of tendering for major infrastructure jobs in Sarawak (e.g.: Sarawak Coastal Road, Second Link Road and Sarawak State Water Grid) with a tender-book of c.RM3-4b. Its current outstanding order-book stands at c.RM3.1b providing 3-4 years visibility.

Earnings estimates. Trim FY19E earnings by 4% as we reduce GP margin assumptions (-0.5ppt) and introduce FY20E earnings of RM72.8m based on FY19-20E replenishment target of RM400m each. Assuming HSL is able to secure a sizable contract from its tender for major infrastructure jobs in Sarawak of c.RM400.0m on top of our initial assumptions, our FY19-20E earnings could be boosted by c.5-7%.

Maintain UNDERPERFORM with a lower Target Price of RM1.25 (from RM1.30) based on FY19E PER of 10x after trimming FY19E earnings by 4%. We base our TP on FY19E PER of 10.0x which is close to its 5-year -1.5SD level, at the higher end of the ascribed 6-11x PER valuation range of small-mid cap contractors.

Risks to our call include: higher-than-expected job wins, accelerated construction billings progress and higher-than-expected construction margins.

Source: Kenanga Research - 27 Feb 2019