Hock Lian Seng Holdings - DBS Research 2017-12-05: Cash Rich With An Option On Shine

Hock Lian Seng Holdings - DBS Vickers 2017-12-05: Cash Rich With An Option On Shine HOCK LIAN SENG HOLDINGS LTD J2T.SI

Hock Lian Seng Holdings - Cash Rich With An Option On Shine

  • Hock Lian Seng Holdings (HLSH) is sitting on 22.6 Scts net cash per share, with firm revenue outlook from S$830m order book.
  • Earnings to normalise in FY17F after a strong 2016, which included one-offs and contributions from a residential project.
  • Foresee a better FY18F on a sustained ramp-up in civil engineering activities, with possible upside from Shine @ Tuas South and/or further contract wins.
  • Fair value of S$0.58 (11x FY18F PE); prospective 5.5% yield.



The Business 


Reputed civil engineering group a leading contender of upcoming tenders for Singapore public sector projects. 

  • The Singapore government plans to push out a strong pipeline of large-scale infrastructure projects over the next few years. Given its track record and extensive experience in civil engineering projects of different scales and complexities, we see Hock Lian Seng Holdings (HLSH) as a beneficiary of these initiatives.

Substantial engineering order book of c.S$830m (as at end- 2Q17) offers visibility. 

  • Earnings are expected to normalise in FY17F after a strong 2016, which included a write-back and contributions from a residential project. Further ahead, the planned execution of its S$830m order book over the next 4-5 years offers visibility while HLSH’s recent 3Q17 performance suggests that a higher proportion of its existing contracts are entering the active stages of construction. 
  • With momentum set to strengthen, we predict that earnings could nearly double from S$13.8m in FY17F to S$27m in FY18F.

Possible upside from industrial development Shine @ Tuas South and new contract wins. 

  • While sales for Shine have been slow, dissipating supply supports an uneven recovery for the industrial sector from 2H18 onwards – which could benefit HLSH later on. However, with absorption still weak currently, we have not factored any contributions from Shine into our projections.


THE STOCK


Fair value of S$0.58 (based on 11x FY18F PE), with prospective 5.5% yield. 

  • Currently trading at c.17% discount to peers average 11x FY18F PE - and under 5x ex-cash PE, we believe HLSH deserves to at least trade at the peer average given its strong business fundamentals (reflected in its superior margins).



REVENUE DRIVERS 


Leading civil engineering group in Singapore.

  • Established in 1969, construction company, Hock Lian Seng Holdings (‘HLSH”) has undertaken a wide range of civil engineering and infrastructure projects for both the public and private sector in Singapore, and now ranks among the largest civil engineering groups locally. Milestone projects for the group include the Marina Coastal Expressway, MRT Stations, MRT depots and airport infrastructure.
  • Registered with the Building Construction Authority (BCA) as a Grade A1 contractor – the highest available grade for civil engineering and building works, HLSH enjoys a wider opportunity set for Singapore public sector projects (compared to peers in the A2 category and below) as its project tenders are not limited by contract value.
  • While forays into property development (in FY12) have yielded positive results, the group has been selective in taking on projects in this space. As such, we believe that Civil Engineering will remain the key sales contributor going forward. Industrial development Shine @ Tuas South (details in Appendix) is scheduled for completion in 2Q18, and could provide an added boost in FY18F (or later) if demand for industrial properties picks up.

Planned execution of S$830m (est.) order book over next 4-5 years. 

  • In 2H16, a joint venture between Hock Lian Seng Holdings (HLSH) (which holds a 60% share) and Sembcorp Design and Construction Pte Ltd was awarded a S$1.107bn tender for development works at Changi Airport, which is scheduled to be completed by 2022.
  • With this high-profile win, HLSH’s order book stood at approximately S$830m as at end-3Q17. With good visibility from the planned execution of its order book over the next 4- 5 years, we forecast revenue to grow to S$153m/S$217m in FY17F/18F, with upside from further contract wins.


BALANCE SHEET & COST STRUCTURE 


Strong balance sheet with substantial net cash of over S$115m. 

  • Apart from its track record, HLSH’s financial position is a key consideration in the tender selection process for Singapore public sector projects. In this regard, a strong balance sheet with S$115m net cash (or approximately 46% of current market cap) would put HLSH in good stead to secure tenders of large-scale projects.

Ability to manage costs over project life cycle is key. 

  • Key costs in civil engineering projects are labour, raw material and equipment costs. Labour typically makes up 20% of construction costs, while raw materials and construction equipment generally represents between 50% and 70% of total costs on average, depending on project complexity.
  • With competition intensifying, firms have been bidding on projects at thinning margins. Further, with contract values determined at the onset, the onus is on the company to manage costs. HLSH has historically done well in this aspect, delivering above-average gross margins of 14-39% for this segment over FY13-FY16.


GROWTH PROSPECTS 


Strong pipeline of public sector projects available for tender.

  • To moderate subdued private sector construction demand, the Singapore government has communicated plans to push out a strong pipeline of large-scale infrastructure projects over the next few years. On top of S$700m worth of contracts announced during the Budget in February, the government shared in September 2017 that it will also bring forward S$700m worth of public amenity projects to 2017 and 2018.
  • Apart from the North-South Highway, large-scale projects potentially up for tender include the Land Transport Authority (LTA)’s Jurong Region Line, Cross Island Line and Changi Airport Terminal 5. Given its established track record and extensive experience in civil engineering projects of differing scales and complexities, we see HLSH as a leading contender in securing some of these contracts.

Acquisition of new development projects. 

  • Similar to FY14 and FY15 – which benefitted from the completion and sale of industrial development projects Ark@Gambas and Ark@kb respectively, the acquisition of new development projects could help catalyse future earnings. 
  • Armed with substantial net cash of over S$115m as at end-3Q17, we believe that HLSH has sufficient firepower to seize attractive property development opportunities that may arise.

Privatisation or higher dividend payout could help extract value for shareholders. 

  • Currently c.54% majority owned, and with share price 50% backed by net cash, we see HLSH as a potential privatisation candidate for the Chua family.
  • On top of a regular 2.5-Sct dividend for FY16, HLSH also paid a special 10-Sct dividend in May. With current net cash position far exceeding working capital needs (especially for LTA projects, for which construction companies typically receive partial upfront payment), shareholders could continue to benefit from similar payouts ahead.


MANAGEMENT & STRATEGY 


Highly experienced and committed management team.

  • Helmed by founder, Mr Chua Leong Hai (who carries over four decades of experience in the civil engineering space), we believe that Hock Lian Seng Holdings (HLSH) is one of the better-run construction companies in Singapore. 
  • Individually, key members of the company, such as Mr David Chew, Ms Chong Lee Yin and Technical Director, Mr Chua Sey Kok, also carry decades of experience and their management team at HLSH boasts decades of experience in their respective fields.
  • While the founder remains very much involved in the business, we note that his children are already involved in the company in various capacities.

Management’s interest aligned with shareholders'. 

  • We see management’s interest as aligned with shareholders' given that the founder (CEO) and his family collectively own a substantial 53.76% stake in HLSH. 
  • While the group does not have a fixed dividend policy, it has typically paid out at least 30% of profits in dividends over the last few years.


VALUATIONS 


Currently trading at c.17% discount to peers’ average c.11x FY18F PE. 

  • Hock Lian Seng Holdings (HLSH) currently trades under 9x FY18F PE (or < 5x on an ex-cash basis given net cash of c.22.6 Scts per share as at end-3Q17), at a 17% discount to peers’ average of c.11x. 

Fair value of S$0.58 with prospective 5.5% yield and possible upside from Shine. 

  • Given its strengths in civil engineering (reflected in its superior margins), strong track record and recent ramp-up on its current order book of c.S$830m (as at end-3Q17), we believe that HLSH deserves to at least trade at the peer average of construction stocks listed on the SGX, and thus value the company at S$0.58 (based on 11x FY18F PE). 
  • Assuming that the fixed 2.5-Sct dividend paid in FY15/16 is maintained, a prospective 5.5% yield is also on offer – with possible upside in FY18F if sales for its development project Shine @ Tuas South pick up.


RISKS 


Shortage of manpower, cost overrun. 

  • Shortage of skilled and experienced manpower in this tight labour market could affect the completion and delivery of projects within schedule. Cost overrun is another key challenge for the group. 






Return *: 1 
Risk: Moderate 
Potential Target 12-mth* : 12-Month S$ 0.58.




Carmen TAY DBS Vickers | Alfie YEO DBS Vickers | http://www.dbsvickers.com/ 2017-12-05
DBS Vickers SGX Stock Analyst Report NOT RATED Explore NOT RATED 0.58 Same 0.58

* This Equity Explorer report represents a preliminary assessment of the subject company, and does not represent initiation into DBSV’s coverage universe. As such DBSV does not commit to regular updates on an ongoing basis. The rating system is distinct from stocks in our regular coverage universe and is explained further on the back page of this report.


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