HSS Engineers HSS MK Sector: Engineering Construction

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1 Positive prospects HSS could secure more contracts like ECRL, Pan Borneo and HSR with its tender book of RM2-300m. We tweaked our FY17E earnings to reflect better timing in securing new contracts and progress billing on its existing order book of RM358m. We upgrade our TP for HSS to RM1.34, giving potential upside of 20% (based on 2018E PER of 17x). Share price has reacted positively to the Securities Commission and Bursa Malaysia s recent approval of HSS listing transfer to Main Board. HSS remains our top small-cap top BUY among construction stocks. High chances of securing more contracts HSS has good prospects to secure more new contracts like East Coast Rail Link (ECRL), Kuala Lumpur-Singapore High Speed Rail (HSR) and Pan Borneo Highway (PBH) Sabah with tender book worth RM2-300m. Conventionally, it is likely to secure detailed design contracts with higher value subsequent to the preliminary design contracts clinched. HSS won total preliminary design contracts worth RM22.6m for ECRL. It was the only local consultant appointed for this project out of 4 consultants. The other 3 were consultants from China. Typically, preliminary design accounts for 20-25% of total project value that HSS could potentially win. Tweaked our earnings We tweaked our FY17E earnings to reflect better timing in securing new contracts and progress billing on its existing order book of RM358m as at 31 Aug Thus, we reduce FY17E EPS by 17% to 4.7sen, while still maintaining our new contract assumptions of RM1-200m per annum in FY17-19E. So far, HSS has secured RM82.2m worth of new contract year-todate, comprising 55% of our new contract assumption of RM1m in FY17E. Some major contracts secured are HSR (RM17.6m), Tun Razak Exchange (RM19m), ECRL (RM22.6m) and Bukit Bintang City Centre (RM6.3m) projects. Management is still exploring potential M&A in water consulting business, which could boost earnings and generate recurring income from operation and maintenance services. Upgraded TP to RM1.34 We upgrade our TP for HSS to RM1.34, giving a potential upside of 20%. This is based on target 2018E PER of 17x and PER-to-growth of 0.6. This is justified given its; i) high chances of securing more contracts as a Bumiputerastatus company; ii) healthy order book replenishment; iii) high PAT margin business model of 10%; iv) high core ROE of 18-26% for FY17-19E; and v) 3-year EPS CAGR of 26% in FY17-19E. Maintain BUY. Key downside risks to our call Earnings lag due to the timing of contract wins; ii) execution risks involved in its expansion plans; iii) a slowdown in construction contract awards. Earnings & Valuation Summary FYE 31 Dec 2015A 2016A 2017E 2018E 2019E Revenue (RMm) EBITDA (RMm) Pretax profit (RMm) Net profit (RMm) EPS (sen) PER (x) Core net profit Core EPS (sen) Core EPS growth Core PER (x) Net DPS (sen) NA Dividend Yield NA EV/EBITDA (x) Chg in EPS (17.0) 0.1 (0.2) Affin core/consensus (x) NA NA Source: Company, Bloomberg, Affin Hwang forecasts Company Update HSS Engineers HSS MK Sector: Engineering Construction 25 August 2017 BUY(maintain) Upside: 20% Price Target: RM1.34 Previous Target: RM1.20 (RM) Aug-16 Oct-16 Dec-16 Feb-17 Apr-17 Jun-17 Aug-17 Price Performance 1M 3M 12M Absolute 25.1% 21.1% 93.1% Rel to KLCI 24.7% 21.4% 83.4% Stock Data Issued shares (m) Mkt cap (RMm)/(US$m) 357.4/83.7 Avg daily vol - 6mth (m) wk range (RM) Est free float 78.2% BV per share (RM) 0.26 P/BV (x) 4.31 Net cash/(debt) (RMm) (2Q17) 29.8 ROE (2017E) 20% Derivatives Nil Shariah Compliant No Key Shareholders Datuk Sri Ir Kunasingam 31.3% Vanessa A/P Santhakumar 31.3% Dato Ir Nitchiananthan 2.7% Source: Company, Bloomberg Loong Chee Wei, CFA (603) cheewei.loong@affinhwang.com Cassandra Ooi (603) cassandra.ooi@affinhwang.com Page 1 of 5

2 Fig 1: Contract awards (RMm) Contracts secured Contracts assumptions E 2018E 2019E Source: Company, Affin Hwang estimates Fig 2: Revenue and order book Revenue (LHS) (RMm) Orderbook end-dec (LHS) Revenue as a % of orderbook (RHS) E Source: Company, Affin Hwang estimates Fig 3: Major contracts secured in FY17(year-to-date) Project Scope of Works Contract Value (RMm) Water treatment in Kedah Engineering Design 3.2 ECRL Phase 1 Scheme Design 4.4 Kuala Lumpur- Singapore High Speed Rail Reference Design Consultant 17.6 ECRL Phase 2 Scheme Design and Feasibility Study 1.9 Proposed TRX External Roads Design Consultancy and Construction Supervision 19.0 ECRL (KM 0 to KM220)* Preliminary Design for infrastructure works 16.3 BBCC External Infrastructure Works (Civil & Structural and Mechanical & Electrical Engineering) Engineering Consultancy 6.3 Total 68.7 Source: Company Re-rating HSS with an upgraded TP of RM1.34 The global and local peers are trading at a forward 2018E PER of 18x (Previous:18.6x). Target prices for small and mid-cap construction stocks under our over coverage based on average target 2018E PER of 17x. Peer average forward PER has been falling mainly due to EPS upgrades, given the rising infrastructure spending in the region especially Malaysia. Mergers and acquisitions of engineering consulting firms in Asia-Pacific region are also on the rise, driving up PERs by setting high benchmark valuations. For example, WSP has proposed to acquire Opus International Consultants Ltd at a historical PER of 35.5x in 2016 (based on 2016 s core net profit of NZD7.7m as Opus incurred net loss of NZD30m due to impairment of assets in 2016) and 16.3x in 2015 (based on 2015 s net profit of NZD16.8m). Hence, this will spur an upward re-rating of HSS. We are upgrading our TP to RM1.34 with a potential upside of 20%. Our TP is based on target 2018E PER of 17x and PER-to-growth of 0.6. This is justified given its: i) high chances of securing more contracts as a Bumiputera-status company with tenderbook of RM2-300m; ii) healthy orderbook replenishment; Page 2 of 5

3 iii) high PAT margin business model of 10%; iv) high core ROE of 18-26% for FY17-19E; and v) 3-year EPS CAGR of 26% in FY17-19E. Fig 4: Small and mid-cap construction peer comparison Stock Bbg Rating Sh Pr TP Mkt cap Core PER (x) Core EPS gr P/BV (x) ROE DY Targeted PER (RM) (RM) (RMbn) CY17E CY18E CY17E CY18E CY17E CY17E CY17E (x) SunCon SCGB MK HOLD AQRS AQRS MK BUY WZ Satu WENG MK BUY Pintaras PINT MK BUY HSS HSS MK BUY Wgt avg Source: Affin Hwang, Company Fig 4: Global and local peers comparison Companies Stock Price TP Ticker Mkt Cap Core PE (x) EPS growth P/B ROE Div. Yield (Local currency) (RM) (USDm) CY17E CY18E CY17E CY18E (x) CY17E CY17E MONADELPHOUS MND AU N/R 1, WORLEYPARSONS WOR AU N/R 2, nm WSP GLOBAL WSP CN N/R 4, STANTEC INC STN CN N/R 3, nm SHANDONG SUNWAY CH 8.06 N/R nm ARTS GROUP CH N/R SINOMA CH 8.71 N/R 2, CHINA ZHONGHUA CH N/R 3, NBCC INDIA NBCC IN N/R 2, ENGINEERS INDIA ENGR IN N/R 1, SWECO AB-B SHS SWECB SS N/R 2, AF AB-B SHS AFB SS N/R 1, RICARDO PLC RCDO LN 7.02 N/R nm SPIRAX-SARCO SPX LN N/R 5, AECOM ACM US N/R 4, AWC AWCF MK 1.12 N/R UEM EDGENTA UEME MK 2.72 N/R HSS HSS MK 1.12 BUY Average Source: Affin Hwang, Bloomberg estimates Page 3 of 5

4 HSS Engineers - FINANCIAL SUMMARY Profit & Loss Statement Key Financial Ratios and Margins FYE 31 Dec (RMm) 2015A 2016A 2017E 2018E 2019E FYE 31 Dec (RMm) 2015A 2016A 2017E 2018E 2019E Revenue Grow th Operating expenses (105.9) (116.7) (112.8) (192.7) (233.9) Revenue (2.3) EBITDA EBITDA Depreciation (1.4) (1.4) (1.2) (1.4) (1.7) Core net profit EBIT Net int income/(expense) (1.0) (0.9) (0.8) Profitability Associates' contribution EBITDA margin Forex gain/(loss) 0.6 (0.2) PBT margin Exceptional gain/(loss) (0.3) (0.2) Net profit margin Pretax profit Effective tax rate Tax (3.6) (5.9) (6.2) (10.3) (12.0) ROA Minority interest Core ROE Net profit ROCE Dividend payout ratio Balance Sheet Statement FYE 31 Dec (RMm) 2015A 2016A 2017E 2018E 2019E Liquidity Fixed assets Current ratio (x) Other long term assets Op. cash flow (RMm) (0.0) 18.6 Total non-current assets Free cashflow (RMm) (1.8) 16.5 FCF/share (sen) (0.6) 5.2 Cash and equivalents Debtors Asset management Other current assets Debtors turnover (days) Total current assets Stock turnover (days) Creditors turnover (days) Creditors Short term borrow ings Capital structure Other current liabilities Net gearing 0.1 net cash net cash net cash net cash Total current liabilities Long term borrow ings Other long term liabilities Quarterly Profit & Loss Total long term liabilities FYE 31 Dec (RMm) 2Q16 3Q16 4Q16 1Q17 2Q17 Shareholders' Funds Revenue Operating expenses (28.2) (33.7) (26.5) (24.4) (32.8) Cash Flow Statement EBITDA FYE 31 Dec (RMm) 2015A 2016A 2017E 2018E 2019E Depreciation (0.4) (0.4) (0.4) (0.3) (0.3) PAT EBIT Depreciation & amortisation Net int income/(expense) (0.3) (0.3) (0.0) 0.0 (0.1) Working capital changes (0.9) (12.7) 7.5 (28.1) (13.8) Associates' contribution (0.0) Others (5.5) Forex gain/(loss) (0.0) (0.0) Cashflow from operation (0.0) 18.6 Exceptional items (0.2) (0.1) (0.2) Capex (1.4) (0.9) (1.0) (1.7) (2.1) Pretax profit Disposal/(purchases) Tax (1.5) (0.8) (2.5) (1.4) (1.5) Others 0.0 (0.4) Minority interest Cash flow from investing (1.3) (1.2) (1.0) (1.7) (2.1) Net profit Debt raised/(repaid) 1.0 (2.6) Core net profit Net interest income/(exp) (1.0) (0.9) (0.8) Dividends paid 0.0 (1.8) (5.5) (7.6) (8.8) Margins Others (1.9) 26.9 (0.8) (1.6) (1.8) EBITDA Cash flow from financing (1.9) 21.7 (7.1) (9.2) (10.4) PBT Net profit Free Cash Flow (1.8) 16.5 Page 4 of 5

5 ` 28 August 2017 Equity Rating Structure and Definitions BUY Total return is expected to exceed +10% over a 12-month period HOLD Total return is expected to be between -5% and +10% over a 12-month period SELL Total return is expected to be below -5% over a 12-month period NOT RATED Affin Hwang Investment Bank Berhad does not provide research coverage or rating for this company. Report is intended as information only and not as a recommendation The total expected return is defined as the percentage upside/downside to our target price plus the net dividend yield over the next 12 months. OVERWEIGHT Industry, as defined by the analyst s coverage universe, is expected to outperform the KLCI benchmark over the next 12 months NEUTRAL Industry, as defined by the analyst s coverage universe, is expected to perform inline with the KLCI benchmark over the next 12 months UNDERWEIGHT Industry, as defined by the analyst s coverage universe is expected to under-perform the KLCI benchmark over the next 12 months This report is intended for information purposes only and has been prepared by Affin Hwang Investment Bank Berhad (14389-U) ( the Company ) based on sources believed to be reliable. However, such sources have not been independently verified by the Company, and as such the Company does not give any guarantee, representation or warranty (express or implied) as to the adequacy, accuracy, reliability or completeness of the information and/or opinion provided or rendered in this report. Facts, information, views and/or opinion presented in this report have not been reviewed by, may not reflect information known to, and may present a differing view expressed by other business units within the Company, including investment banking personnel. Reports issued by the Company, are prepared in accordance with the Company s policies for managing conflicts of interest arising as a result of publication and distribution of investment research reports. Under no circumstances shall the Company, its associates and/or any person related to it be liable in any manner whatsoever for any consequences (including but are not limited to any direct, indirect or consequential losses, loss of profit and damages) arising from the use of or reliance on the information and/or opinion provided or rendered in this report. Any opinions or estimates in this report are that of the Company, as of this date and subject to change without prior notice. Under no circumstances shall this report be construed as an offer to sell or a solicitation of an offer to buy any securities. The Company and/or any of its directors and/or employees may have an interest in the securities mentioned therein. The Company may also make investment decisions or take proprietary positions that are inconsistent with the recommendations or views in this report. Comments and recommendations stated here rely on the individual opinions of the ones providing these comments and recommendations. These opinions may not fit to your financial status, risk and return preferences and hence an independent evaluation is essential. Investors are advised to independently evaluate particular investments and strategies and to seek independent financial, legal and other advice on the information and/or opinion contained in this report before investing or participating in any of the securities or investment strategies or transactions discussed in this report. Third-party data providers make no warranties or representations of any kind relating to the accuracy, completeness, or timeliness of the data they provide and shall not have liability for any damages of any kind relating to such data. The Company s research, or any portion thereof may not be reprinted, sold or redistributed without the consent of the Company. The Company, is a participant of the Capital Market Development Fund-Bursa Research Scheme, and will receive compensation for the participation. This report is printed and published by: Affin Hwang Investment Bank Berhad (14389-U) A Participating Organisation of Bursa Malaysia Securities Berhad 22nd Floor, Menara Boustead, 69, Jalan Raja Chulan, 200 Kuala Lumpur, Malaysia. T : F : research@affinhwang.com Page 5 of 5