Hock Lian Seng Holdings - Phillip Securities 2016-07-04: More weaknesses expected

HOCK LIAN SENG HOLDINGS LTD J2T.SI

Hock Lian Seng Holdings - More weaknesses expected

Hock Lian Seng Holdings (HLSH) is expected to face challenges in operating performance as competition intensifies in the civil engineering sector amid the ongoing slowdown in private sector construction demand.
Coupled with the absence of revenue contribution from property development, we expect both earnings and dividends to decline over the next few years till 2018 when the development of the group’s industrial property is completed.

We have initiated coverage on HLSH with a “Reduce” rating based on a SOTP valuation of S$0.31.

Public sector construction demand in 2016 is expected to be the highest since 2002 as private sector construction demand weakens.
Civil engineering construction demand is expected to accelerate in 2016 and poised to stay strong at least till 2020.
Real estate construction activities are slowing down from excess supply of unsold residential units in the market.
Grade A1 contractors are able to participate in project tenders of higher contract value where contractors with lower BCA grades are not eligible for.
Contractors registered under BCA have to meet ongoing requirements in order to maintain their respective grades.
Competition is heating up as more contractors are increasingly hungry for project and returning to public sector projects.
Margins in the sector are expected to reduce further as labour costs continue to expand, and uncertainties from costs of construction materials.

Weaknesses in civil engineering revenue and gross margins to persist as competition intensifies from subcontractors in public project tenders
Performance of civil engineering segment in FY16 is expected to be lacklustre
Sales in new industrial property project expected to be weak amid keen competition and
the slower real estate market
Limited impact and growth opportunities in view of the slowing private residential
property market decline with the group’s JV residential development project being
99.5% sold
Full year earnings in 2016 expected to be lowest in three years since 2014 mainly due to the absence of revenue contribution from property development and a muted property investment segment.
Limited avenues to deploy growing cash reserves as a solid financial position is required to win projects in the public sector.
Dividend payments to fall in the next three years as earnings are expected to drop and management is unlikely to maintain dividend payments through the use of cash.

Strong balance sheet and proven history of track record can help to secure future new projects.
Not subjected to existing property cooling measures (additional buyers stamp duty) imposed on residential properties since The Skywoods is close to being completely sold (99.5%).

Securing of new civil engineering projects.
Stronger than expected take up rate for new industrial property development, Shine@Tuas South.

Earnings are expected to be weak in the near term:
1. Lower margins on existing civil engineering projects.
2. Absence of revenue recognition from property development compared to prior years.
Dividend payments are expected to decline in tandem with weaker earnings.
Limited avenues to deploy cash reserves as excess cash is tied up mainly to serve as working capital for new civil engineering projects.

Higher than projected increase in construction material prices which further compresses existing gross margins.
Rising level of competition causes the clinching of new projects to become tougher, and potentially lower gross margins even if secured.
Sales at Shine@Tuas South is likely to be slow due to the current oversupply of industrial properties.

Peter Ng Phillip Securities | http://www.poems.com.sg/ 2016-07-04

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