Momentum building up at Hock Seng Lee

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Hock Seng Lee Bhd (Oct 27, RM1.86)Maintain buy at RM1.82 with revised target price of RM2.30 (from RM1.90): Recent news flow involving Sarawak, in particular Mubadala’s US$7 billion (RM21.8 billion) investment pledge and a good share of Budget 2011 allocations, are indications of rising construction job flows. We retain our RM600 million 2010 job win target for HSL, but lift our 2011 target to RM720 million (+20%). We also raise our 2011 net profit forecast by 11% and 2012 by 9%. Our new target price, based on a higher 14 times 2011 earnings multiple (previously 13 times) at RM2.30 (+21%).

The Abu Dhabi investment arm’s tie-up with 1Malaysia Development Bhd (1MDB), inked on Oct 8, may lead to an investment of up to US$7 billion for projects in Sarawak’s Corridor of Renewal Energy (SCORE), including an aluminium smelter plant. With the Bakun hydropower project ownership moving to the state, Sarawak will be able to price electricity more competitively to draw new energy intensive industries. Mubadala is the second major win for SCORE. In January this year, 1MDB inked an agreement with China’s State Grid Corp for three hydrodams and an aluminium smelter plant.

Some RM4 billion of the total RM49 billion development expenditure under the Budget 2011 is allocated to Sarawak under the Economic Transformation Programme’s (ETP) National Key Result Areas projects, according to the chief minister. Most of this is for rural infrastructure projects comprising roads, water and electricity. In addition, 68 of the ETP’s 131 Entry Point Projects (EPP) will impact Sarawak, according to Prime Minister Datuk Seri Najib Razak. Sarawak contractors will benefit from infrastructure demand to support the EPPs.

HSL should meet our RM600 million new job target for 2010, having secured RM432 million year-to-date. Its outstanding order book stands at RM1.25 billion, sufficient to provide for two years of strong earnings growth (+20% per year) into 2011. We raise our earnings forecasts after incorporating higher job wins for 2011 and a higher blended gross margin assumption of 19% to 20% for construction (previously 17% to 18%). We expect HSL to sustain its construction margin (1H10: 19.3%).

We raise our PER valuation target for HSL on expectation of higher liquidity flows into the stock. Sarawak stock options are fewer with the privatisation/delisting of UBG-Loh & Loh. UBG will be suspended from trading on Nov 2. Interest in Sarawak stocks will also be sustained by an upcoming state election which must be called by May 2011. — Maybank IB Research, Oct 27

This article appeared in The Edge Financial Daily, October 28, 2010.