Hock Seng Lee – Robust Order Book Of RM2.3 Billion, Possible 30% Upside?

Singapore’s land size has grown by approximately 22 percent since its British colonial times, all made possible with land reclamation. The process, which usually involves filling up areas of wetlands or sea with a mixture of sand, cement and other materials to create new land, actually falls under the civil engineering segment of the broader construction industry.

To be more precise, land reclamation, dredging and other specialised water-related engineering projects falls under a niche segment called marine engineering (or marine civil engineering).

This time round, we take a closer look at Sarawak-based infrastructure firm Hock Seng Lee (HSL), who is seen as a beneficiary of the increased infrastructure spending in the region. Given Sarawak’s swampy terrain, reclamation usually needs to be carried out before most construction activity can take place and HSL with its marine engineering expertise has an edge in this area.

Business

HSL started as a company principally engaged in dredging and land fill operations. As the firm grew in size, it began undertaking land reclamation projects of larger size and complexity, establishing itself as the Sarawak’s market leader in land reclamation.

Along the way, the group also acquired complementary expertise in soil improvement works, shore protection, drainage and water reticulation activities. Consequently, the firm diversified into a wide range of civil engineering and constructions works, which includes road works, township developments, tunnel boring as well as other infrastructure projects.

While the company has also dabbled in property development, its construction business is still the largest revenue contributor, accounting for 95.1 percent of FY15 turnover.

Since its listing in 1996, revenue has been on a general uptrend, albeit lumpy at times due to the nature of its project-based business. Similarly, net profit has also been fluctuating over the years, underpinned by the lumpy revenue recognition and cost pressures faced. That said, HSL has remained profitable each year since its listing, a commendable record.

Promising Outlook Underpinned By RM2.3b Order Book

Based on the close price of RM1.75 per share as of 28 September, HSL’s shares have slid approximately 18.2 percent from a high of RM2.14 per share in March. Apart from market volatility, the lacklustre 1H16 results was probably a main contributor to the poor share price performance.

For 1H16, top line fell 25.8 percent to RM249.3 million while earnings declined 22.9 percent to RM28.3 million. The weaker results were mainly attributable to lower revenue contribution for newer projects and the completion of older projects.

However, turnover and net profit are expected to pick up in 2H16, on the back of successive job wins for two major projects worth RM1.9 billion in 1Q16. The two contracts secured were for the RM750 million Kuching City Central Wastewater Management System (Package 2) project (HSL’s stake: 70 percent) and the RM1.7 billion Pan-Borneo Highway package 7 (HSL’s stake: 75 percent).

With the latest contract wins, HSL’s order book was boosted to RM2.3 billion as of 30 June 2016, which should keep the firm busy and provide earnings visibility for the next four to five years. As the new projects were only secured in March, revenue recognition was negligible for 1H16 though the pace is projected to pick up going forward.

Healthy Balance Sheet With Zero Debt

Apart from the outstanding order book, HSL also boasts a strong balance sheet with no debt and RM113.8 million in cash and equivalent and short-term investments as of 30 June 2016.

While the current dividend yield of around 1.4 percent is nothing to shout out about, we like that the firm has been consistently rewarding shareholders with dividend payouts in each year since its listing.

Despite being optimistic about HSL’s earnings going forward, supported by its RM2.3 billion construction order book and ongoing property development projects, we also note some of the risks that the firm could face.

Firstly, given the huge order book, execution risks exist and delay in the projects could negatively impact its performance. Additionally, a sudden spike in costs (labour, raw material etc.) could also hurt the company’s margins. Lastly, a reduction in government infrastructure spending is also a threat to the group as its construction division relies rather heavily on public projects.

Overall though, analysts on the streets appear to be rather optimistic on HSL, with the consensus rating equivalent to a ‘Buy’ call and an average target price of RM2.26, which implies a possible 29.1 percent upside from the close price of RM1.75 on 28 September.

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