Exciting Potential

We reiterate our BUY call on HSS Engineers and TP of RM1.20, based on a 2018E PER of 15x. We continue to like HSS for its i) healthy orderbook replenishment; ii) high-margin business model; iii) long-standing relationship with clients like Prasarana, MRT Corp, and myHSR; iv) shareholding structure that positions its associate HSS Integrated (HSSI) as a Bumiputera company with a competitive advantage in governmentcontract bids; v) proposed listing transfer to the Main Board and inclusion on the Shariah-compliant stock list which are on track, and would help to raise its profile among institutional investors.

Healthy Order-book Replenishment

HSS is confident of securing more contracts as RM141bn worth of infrastructure projects are expected to kick off in 2017-18. Upcoming projects include the East Coast Rail Link (ECRL), Pan Borneo Highway Sabah and KL-Singapore High Speed Rail (HSR). HSS clinched RM40m worth of contracts YTD, or 27% of our 2017E new contract assumption of RM150m. Order book of RM383m as at 31 March 2017, equivalent to 2.8x 2016 revenue of RM139m, supports revenue growth ahead, in our view.

High-margin Business Model

Typically, the engineering design fee charge is about 2-5% of total project costs. ECRL’s engineering design fees could be worth up to RM1.1bn, based on 2% of RM55bn project value. We gather that the design work may be divided into 4-5 packages with an estimated value of RM220-275m each. HSS could also bid for the independent consultant engineer (ICE) role for ECRL, deriving typically high gross margins of 50%, compared to engineering services’ gross margin of 35%. The largest cost item for HSS is manpower cost, which is about 67% of revenue.

Bumiputera Firm Advantage

HSS’ 30%-owned associates HSSME and HSSI plan to bid on the above contracts. Under the Teaming and Support Services Agreement with HSS, at least 98.75% of the professional fee earned by HSSME and HSSI flows to HSS, protecting the interest of the listed-company shareholders. Dato’ Ir Khairudin owns 60% and 50% of HSSME and HSSI, respectively. Coupled with 57% of its staff being Bumiputera, HSS qualifies as a Bumiputera firm, which provides a competitive advantage in government contract bids.

Reiterating Our BUY Call and TP of RM1.20

We maintain our earnings forecasts and reiterate our BUY call. Our 12- month TP of RM1.20 is based on a 2018E PER of 15x, a c.20% discount to the global peers’ weighted average PER of 18.6x. We believe the recent share-price correction offers a buying opportunity ahead of potential positive news flow. Key downside risk: bid losses on upcoming tenders.

Source: Affin Hwang Research - 23 Jun 2017