This article first appeared in The Edge Financial Daily on August 18, 2017

HSS Engineers Bhd
(Aug 17, 98 sen)
Maintain buy with an unchanged target price (TP) of RM1.20: Revenue increased by 12.7% year-on-year (y-o-y) and 29.4% quarter-on-quarter to RM37.9 million, attributable to the contribution of project management fees from mass rapid transit Line 2 and a traditionally weaker first quarter. Earnings before interest and tax improved by 7.7% y-o-y to RM7.7 million in the first half of financial year 2017 (1HFY17), but contracted 6.7% y-o-y to RM4.8 million in the second quarter of FY17 ended June 30, 2017 (2QFY17), while pre-tax profit fell by 7.1% y-o-y, mainly due to higher operating cost (+16.6% y-o-y). HSS Engineers Bhd’s core net profit increased by 22% y-o-y to RM6.5 million in 1HFY17, but declined 1.1% to RM3 million in 2QFY17, although the earnings contribution from its RM18 million high-speed rail reference design contract won in April 2017 partly offset the impact.

HSS’ core net profit of RM6.5 million in 1HFY17 comprised 36% of our estimate of RM18 million for FY17. This was within our expectations as traditionally, 4Q earnings are the strongest compared with the first three quarters. 4Q earnings in FY14, FY15 and FY16 accounted for 47%, 43% and 50% of HSS’ full-year net profits respectively. We maintain our earnings forecasts, supported by an unbilled order book of RM358 million (as at June 30, 2017) and new contracts secured of RM82 million year-to-date (55% of the RM150 million new contract assumption for FY17), including Tun Razak Exchange (RM19 million), East Coast Rail Line (RM16.3 million) and Bukit Bintang City Centre (RM6.3 million) projects.

We reiterate our “buy” call and TP of RM1.20, with a potential upside of 17%. Our TP is based on a calendar year 2018 estimated price-earnings ratio of 15 times, a discount of about 20% to the weighted average PER of 18.6 times for global peers. We continue to like HSS for its: i) healthy order-book replenishment; ii) high-margin business model; iii) long-standing relationship with clients like Prasarana Malaysia Bhd, Mass Rapid Transit Corp Sdn Bhd and MyHSR Corp Sdn Bhd; iv) bumiputera company status with a competitive advantage in government-contract bids; and v) proposed listing transfer to the Main Market of Bursa Malaysia and inclusion in the syariah-compliant stock list, which will likely raise its profile among institutional investors.

Key downside risks to our call include an earnings lag due to the timing of contract wins, execution risks involved in its expansion plans and a slowdown in construction contract awards. — Affin Hwang Capital, Aug 16