This article first appeared in The Edge Financial Daily on July 31, 2018
Hock Seng Lee Bhd
(July 30, RM1.40)
Maintain hold with a lower fair value (FV) of RM1.25: The financial year ending Dec 31, 2019 (FY19) to financial year ending Dec 31, 2020 (FY20) earnings forecast downgrade is largely due to a lower assumption for job wins of RM250 million annually (from RM400 million previously) during our forecast period.
During a recent visit to Hock Seng Lee Bhd (HSL), the company acknowledged that similar to its peers in Peninsular Malaysia, contractors in Sabah and Sarawak are not spared the weakened prospects for job wins over the short term as the government cuts back on public projects on the grounds of fiscal prudence.
However, the fact remains that Sabah and Sarawak are still falling far behind Peninsular Malaysia in terms of infrastructure development. As such, once the dust settles, the rollout of public infrastructure projects in the two states is likely to resume. HSL holds that view that given the budgetary constraints, the government is more likely to focus more on smaller-scale or value-for-money basic infrastructure projects.
We believe these could include road upgrading, bridges, schools, drainage, small water supply and sewerage schemes. As the size of these projects only ranges from RM30 million to RM50 million on one end to less than RM100 million on the other, they are uneconomical to the peninsular boys whose operations in the two states generally carry much higher fixed overheads.
We believe HSL is very well positioned to benefit from the rollout of these small-scale public infrastructure projects in Sabah and Sarawak over the medium to long term given its competitive local workforce, its better control over raw materials — both in terms of supply and pricing — and HSL’s niche strength in ground treatment and land reclamation.
Meanwhile, the progress on HSL’s key construction jobs has finally gathered momentum, after overcoming the initial hiccups such as delays in obtaining the necessary approvals from various authorities as well as vacant possession of project sites.
At present, the completion stands at 30% for the RM1.2 billion work package for the Pan Borneo Highway; 18% for the RM333 million Miri Wastewater Management System, and 5% for the RM563 million Kuching City Central Wastewater Management System (Phase 2).
Collectively, these three jobs make up two-thirds of HSL’s current outstanding construction order book of RM2.5 billion.
In conclusion, we are still cautious about the outlook for the local construction sector. As the government scales back on public projects, local contractors will be competing for a shrinking pool of new jobs in the market. Severe undercutting among the players will result in razor-thin margins for the successful bidders. On the other hand, the introduction of a more transparent public procurement system under the new administration should weed out rent-seekers, paving the way for healthier competition within the local construction sector.
We believe HSL will be able to ride out the current downturn in the local construction sector relatively better than its peers, given its substantial order backlog that should keep it busy over the next three to four years, coupled with its ability to compete under an open bidding system. — AmInvestment Bank, July 30