Hock Lian Seng Holdings: Sustained Margin Decline in Civil Engineering August 12, 2016

PSR Recommendation: REDUCEStatus: MaintainedTarget Price: 0.31
  • Civil Engineering is the only revenue contributor in 1H16 in absence of contribution from property development
  • No new Civil Engineering project was clinched in 1H16

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Sales of newly launched industrial property development, Shine@Tuas South, have been lacklustre and not expecting much upside in sales volume

The new B2 industrial property development project, Shine@Tuas South was launched in 2Q16 ,and sales volume at the development has been weak thus far with only three out of 174 units being sold. This was in line with our expectations considering the weak industrial property landscape amid a lack of demand for industrial space where net absorption of factory space was 19,000 square metres (sqm) in 2Q16, lowest in the past five years. There will be 1.1 million sqm of new factory space to be expected in 2017 versus 1.3 million sqm in 2016. Although the amount of new factory space in 2017 is 15% lower than 2016, however, this is still significant considering the weakness in demand for factory space. As such, we expect weakness in the industrial property space to stretch into 2017. Consequently, we do not expect sales volume of Shine@Tuas South to pick up in the near term.

Gross margin from civil engineering segment continues to taper although rate of decline has slowed down

Gross margin from the Group’s Civil Engineering (CE) segment continued to decline although the rate of decline has begun to slow down. The Group’s CE gross margin in 2Q16 dipped 0.9 ppts to 5.1%. We are of the view that the current CE gross margin for the Group’s existing projects is likely to have stabilised since work in these projects has already picked up in intensity. However, gross margins in newly contracted projects are unlikely to boost existing gross margins considering the intensity of competition for new project tenders among other contractors as mentioned in our initiation report dated 4 July 2016.

Profit contribution from The Skywoods helped to lift 2Q16 earnings; Revenue recognition for this project is mostly complete as at 2Q16

Development profit from The Skywoods has contributed 88% of the Group’s profit before taxes (S$10 million) in 1H16, while the remaining 12% was contributed from the Civil Engineering segment. Recognition of revenue from the joint venture residential development project, The Skywoods, is almost complete as at 2Q16, given that the development has received its temporary occupation permission in May 2016 and the project was 99.5% sold during the same period. From here on, we are expecting profit contribution from the property development segment to come to a halt, given that the recognition of revenue from The Skywoods is near to completion and revenue recognition of the Group’s newly launched industrial property can only occur after the development is completed in 2018.

 

Investment Action

We maintain a “reduce” rating  based on a SOTP valuation of S$0.31 on Hock Lian Seng Holdings (HLSH) amid a continued but slowing decline in gross margin in the Group’s CE segment, which is eating into earnings. Additionally, CE segment is likely to remain as the primary revenue driver for HLSH in the absence of contribution from property development until FY18 based on the Group’s current plans in property development.

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