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HSS Engineers Is Currently Bidding for Railway, Renewable Energy and Water-Related Projects to Expand Its Order Book

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HSS Engineers Is Currently Bidding for Railway, Renewable Energy and Water-Related Projects to Expand Its Order Book 28 January 2019 Water play Company Update HSS Engineers is currently bidding for railway, renewable energy and water-related projects to expand its order book. The government’s ongoing water asset consolidation exercise and planned water tariff HSS Engineers hikes nationwide will support crucial capital expenditure to expand the HSS MK water supply and improve distribution efficiency. The potential revival Sector: Engineering Construction of highway and railway projects will also improve HSS’ new contract procurement prospects. HSS remains our top small-cap sector BUY RM0.99 @ 25 January 2019 with a new target price of RM1.20, based on a FY19E PER of 22x. Bidding for water projects BUY (maintain) State-owned water utility Pengurusan Air Selangor Sdn Bhd has a capex Upside: 21% plan of RM30bn over 30 years starting from this year. Other state governments also plan to increase their capex to improve their water supply Price Target: RM1.20 and distribution systems. We gather that HSS has submitted 10-12 bids for Previous Target: RM1.18 (RM) water infrastructure design contracts nationwide. Some tenders are 2.00 1.80 submitted in partnership with contractors for design and build projects. 1.60 1.40 1.20 High order book even with ECRL cancellation 1.00 0.80 HSS’ order book stood at RM588.6m as at 30 Sept 2018, providing earnings 0.60 0.40 visibility for the next 2-3 years. It has good prospects of winning new 0.20 0.00 contracts this year with potential tenders worth more than RM300m. HSS’ Dec-16 May-17 Oct-17 Mar-18 Aug-18 Jan-19 suspended contracts for the East Coast Rail Link (ECRL) project (remaining Price Performance value of RM95m or 16% of its order book) will likely be cancelled with the project termination; we excluded them from our forecasts earlier. 1M 3M 12M Absolute 19.3 % 23.8 % -35.3 % Looking to participate in upcoming project tenders Rel to KLCI 18.1 % 22.7 % -29.8 % As the leading engineering consulting firm for railway and road projects in Stock Data Malaysia, HSS is looking to participate in upcoming tenders including the following: (1) Iskandar Malaysia Bus Rapid Transit (BRT); (2) Klang Valley Issued shares (m) 495.9 Mkt cap (RMm)/(US$m) 490.9/119.0 Double Tracking (re-tender); (3) Penang LRT; (4) DUKE Phase 2A Avg daily vol - 6mth (m) 3.3 expressway; (5) Kuching LRT; (6) Three paired roads project in Penang; 52 -wk range (RM) 0.45 -1.91 and (7) a Philippine highway. It also plans to expand into renewable energy Est free float 56.0 % BV per share (RM) 0. 67 (RE) generation projects under the third cycle of the large-scale solar (LSS3) P/BV (x) 1. 5 scheme with some partners. Net cash/(debt) (RMm) (44.3) ROE (%) (2018E) 11.0 Sector top small-cap BUY Derivatives Yes We believe HSS is a potential beneficiary of the upcoming infrastructure (Warr 18/23, WP RM0.185, EP RM1.70) Shariah Compliant Yes projects. We lift our core FY19-20 EPS forecasts by 2-6% to reflect higher new contract assumptions of RM200-250m p.a. Based on an unchanged Key Shareholders FY19E PER of 22x, we lift our TP to RM1.20 from RM1.18. Maintain BUY. Tan Sri Ir Kuna singam Sittampalam 24.3% Vanessa A/P Santhakumar 23.2% Earnings & Valuation Summary Datuk Ir Teo Chok Boo 10. 2% FYE 31 Dec 2016 2017 2018E 2019E 2020E Dato’ Ir Nichiananthan 1. 7% Revenue (RMm) 139.0 145.6 184.1 197.0 221.9 Source: Company, Bloomberg EBITDA (RMm) 22.3 24.1 43.3 51.3 55.2 Pretax profit (RMm) 19.9 21.9 30.2 38.5 44.0 Net profit (RMm) 14.0 15.0 21.2 27.0 30.8 Loong Chee Wei, CFA FD EPS (sen) 5.0 4.7 4.6 5.4 6.2 (603) 2146 7548 PER (x) 19.9 21.1 21.8 18.2 16.0 [email protected] Core net profit 14.3 15.8 23.7 27.0 30.8 Core EPS (sen) 4.2 4.6 5.1 5.4 6.2 Core EPS growth (%) 16.5 10.1 9.9 6.7 14.0 Core PER (x) 23.5 21.3 19.4 18.2 16.0 Net DPS (sen) 0.6 0.8 2.4 2.8 2.8 Dividend Yield (%) 0.6 0.8 2.4 2.8 2.8 EV/EBITDA (x) 14.0 12.9 11.3 9.8 8.8 Chg in core EPS (%) 2.3 1.7 5.9 Affin core/Consensus (x) 0.9 0.9 0.8 Source: Company, Bloomberg, Affin Hwang estimates Affin Hwang Investment Bank Bhd (14389-U) Page 1 of 6 ` 28 January 2019 Termination of ECRL project HSS’ contracts for ECRL with an unbilled value of about RM95m have remained suspended since 9 July 2018. We have assumed no earnings contribution from this project in our forecasts. According to newspaper reports quoting the Economic Affairs Minister Datuk Seri Mohamed Azmin Ali, the government has decided to terminate the project and the main contractor China Communications Construction Co. Ltd (CCCC) due to the high total project cost of RM81bn. Hence, HSS’ subcontracts will likely be terminated together with CCCC’s contract as the turnkey contractor for ECRL. We have excluded the earnings contribution from the subcontracts previously in our forecasts for HSS when they were suspended. The news could cause short-term weakness in the share price as the potential cancellation of the project will reduce HSS’ order book by 16% to RM493.6m. But we remain positive on HSS’ prospects to replenish its order book by securing new contracts this year and reiterate our BUY call. Good prospects for water projects in 2019 The Budget 2019 allocated RM690m for the implementation of new water- supply projects and the reduction of non-revenue water (NRW), i.e. water loss due to leakage, theft or meter inaccuracies. The government allocated RM590m in 2019 to build more municipal sewerage treatment plants and network systems to connect households that are still using septic tanks and traditional systems. It is considering raising sewerage tariff rates and implementing combined billing for water and sewerage bills to improve collection, ensuring the sustainability of the sewerage utility company, Indah Water Konsortium. The capex expansion for water and sewerage services is positive for HSS, which is the largest local engineering consulting firm in the water and sewerage sectors following its acquisition of SMHB Engineering last year. Bidding for Sarawak water grid project The group has also submitted tenders for water projects in Sabah and Sarawak given the water shortage and as certain rural areas are not connected to the water grid in these states, which remain key concerns for the state governments. We gather that the Sarawak state government plans to spend RM7-8bn on the state’s water grid project to draw clean water from the hydroelectric dam reservoirs to supply to rural areas and irrigate agriculture projects. Under the project’s first phase, reservoir water will be brought from the Batang Ai hydroelectric dam in southern Sarawak to Tanjung Manis, one of the growth nodes of the Sarawak Corridor of Renewable Energy in central Sarawak. This phase, which has been allocated RM1bn, will be completed within two years. Potential beneficiary of higher water sector capex As a leading engineering consultant firm in the water sector, we believe SMHB Engineering, a wholly-owned subsidiary of HSS, is a potential beneficiary of rising capital expenditure (capex) to develop and upgrade water supply and distribution services in Malaysia. Most states in Malaysia had low capex in the past due to the low consumer water tariff rates that were insufficient to fund the capex, and in some cases were even insufficient to fund the operating expenditure of the state-owned water utility company. Hence, it is positive that the Penang and Negeri Sembilan states plan to Affin Hwang Investment Bank Bhd (14389-U) Page 2 of 6 ` 28 January 2019 increase water tariff rates by up to 20% based on the recommendation of the National Water Services Commission (SPAN). Large capex planned for Selangor The acquisition of SPLASH’s assets by Pengurusan Air Selangor will also consolidate all the water assets in the state under the control of the Selangor state government effective from 1 April 2019. This will support the increase in water tariff to pass on the higher cost of water supply and capex to build new water treatment plants and improve the water distribution network. State-owned water utility Pengurusan Air Selangor Sdn Bhd has a capital expenditure plan of RM30bn over 30 years starting from this year. It is crucial that the Selangor water supply be expanded as the water reserve margin in the state is 0%. Other states with critical water reserve margins include Kedah (0%), Perlis (1%) and Kelantan (5.8%). Fig 1: Water reserve margin by state in 2016 Source: Malaysia Water Industry Guide 2016 Earnings forecast revisions In anticipation of higher government spending on infrastructure and HSS’ strong position to win some of the upcoming project tenders, we lift our core FY19-20 EPS forecasts by 2-6% to reflect higher assumptions of new contracts to be secured, ie, RM200m in FY19E and RM250m in FY20E (previously assumed RM150m and RM200m, respectively). Lower risk profile compared to global peers At the current FY19E PER of 18x, HSS shares are currently trading above their historical mean level (16x), but below the 1 standard-deviation above mean level (21x).
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