Hock Seng Lee Bhd
(Oct 24, RM1.75)
Maintain buy at RM2.03: We cut our financial year ending 2016 (FY16)/FY17/FY18 earnings forecasts for Hock Seng Lee Bhd (HSL) by 28%, 28% and 23% respectively. We downgrade our fair value by 28% to RM2.03 (from RM2.80) based on 15 times revised FY17 earnings per share of 13.5 sen, in line with our one-year forward target price-earnings ratio of 13 times to 15 times for mid-cap construction stocks, but maintain our “buy” call.

The earnings downgrade is to reflect the changes in our assumptions on the timing of the profit recognition, and margins from the two key projects, namely the RM1.7 billion Pan Borneo Highway package (HSL’s 70% share is RM1.2 billion) and the RM750 million Kuching central wastewater management package 2 (HSL’s 75% share is RM563 million).

We gathered on the ground that due to the scale and complexity of these two projects (that make up about 77% of HSL’s total outstanding construction order book of RM2.3 billion currently), they are unlikely to contribute materially to HSL’s bottom line in FY16 during the initial stages of implementation.

In addition, we reduce our margins slightly to better reflect the risk of costs escalation, as well as spread the contributions from these projects over a slightly longer period of time (that translates to lower contributions annually) — to be more prudent.

We now project HSL’s earnings to contract by 11.3% in FY16, but to bounce back strongly by +16.6% in FY17 and +25.6% in FY18, as the two key jobs hit major billing milestones.

We like HSL as it is a good proxy to the booming construction sector in East Malaysia, backed by massive infrastructure developments such as roads (anchored by the Pan Borneo Highway), ports, hydropower plants and water/wastewater treatment facilities. Its earnings visibility is good, underpinned by a record outstanding construction order book of RM2.3 billion that will keep it busy over the next three to four years. — AmInvestment Bank Research, Oct 21