We believe HSL is a front-runner to win a roadwork package for the Pan Borneo Highway (Sarawak). As the contract award is gaining pace, we upgrade HSL to BUY with a revised MYR2.30 TP (19% upside). The firm is also a good proxy to infrastructure spending in Sarawak, backed by the SCORE, urbanisation and rural development.

• Pan Borneo Highway (Sarawak). Hock Seng Lee (HSL) is wellpositioned to take a slice of the action in the MYR16.1bn Sarawak portion of the Pan Borneo Highway project given its dominant position in the state’s construction sector. The company may work with a West Malaysian contractor (HSL to own a 70% stake) to tender for theremaining 10 work packages that we assume to worth MYR1.2bn.
• Other contracts. Aside from the Pan Borneo Highway project, we are projecting regular contract wins amounting to MYR400m (FY16) and MYR450m (FY17). Therefore, the winning of Phase 2 of the Kuching Centralised Sewerage System (worth c.MYR800m based on our estimates) is likely to be a positive surprise. The company’s currentoutstanding construction orderbook stands at MYR600m.
• Forecasts. HSL’s construction margins have been declining in the past few quarters despite remaining superior vs those of its West Malaysian peers, which we suspect was due to higher labour costs. After trimmingour margin assumption, our FY15F-17F earnings are lowered by 1-4%.Risks are contract wins falling short of our assumption and an escalationin input costs trimming profitability.
• Upgrade to BUY. East Malaysia’s construction sector is buoyed by infrastructure works from the Sarawak Corridor of Renewable Energy(SCORE) (roads/water supply/port), urbanisation (flood mitigation/waste management/traffic diversion) and rural development (roads/water supply/housing). W e also like HSL for its higher margins vis-à-vis its peers in West Malaysia, given the less intense competition from only a small pool of contractors. We switch our valuation to SOP, where we value its construction wing at 12x FY16F P/E (in line with our 10-14x 1-year forward target P/Es for small and mid-cap construction stocks). W e give a 35% discount to RNAV for its property unit and add its last net cash to derive a new MYR2.30 TP (from MYR1.75). We upgrade the stock to BUY (from Neutral). This report marks the transfer of coverage to Ng Sem Guan.

Switching to SOP valuation. We realise our previous pure earnings-based valuation using a target P/E has failed to account for the huge hidden value at its property unit and the company’s net cash position. Although its property unit contributes only ~5% of the group’s topline in recent financial years, HSL owns almost 800 acres of prime landbank around Kuching city with a projected GDV of MYR2.8bn. Therefore, we now value the unit at a 35% discount to our projected RNAV. That said, we continue to value its construction wing at 12x FY16F P/E (in line with our 10-14x 1-year forward target P/Es for small and mid-cap construction stocks) due to the short earnings visibility for the construction sector. On top of that, we also added its last reported net cash as at 30 Sep 2015 to derive a new MYR2.30 TP (from MYR1.75). The 19% upside potential from our new TP prompted us to upgrade the stock to BUY (from Neutral).