HSS Engineers's 3Q24F results are due out on 20 Nov. with CGS Investment Bank estimating the quarter to be stronger qoq and yoy in terms of net profit, driven by maiden contribution from its Baghdad metro contract (Baghdad) won in July 24. This will help compensate for the absence of meaningful contribution from its MRT 3 project management consultancy (PMC) contract.

According to HSS, total estimated fees for the Baghdad metro are RM1.49bn, of which HSS's 50% share is RM745m. Of this amount, RM249m (0.6% of total construction cost of RM83bn) relates to the PMC work that commenced in Jul 24 and ends in 3Q25F. Thereafter, the construction supervision services (CSS) contract worth RM497m (1.2% of construction cost of RM83bn) will commence in 3Q25F and end in May 29F. The JV will receive an advance payment of RM74.5m (HSS: RM37m), 15% of the PMC work.

The negative operating cashflow in 2Q24, which was due to a key client migrating to a new payment system, has been resolved and HSS should be cash flow positive in 3Q24F. Key milestone for Baghdad reached; advance payment soon. According to HSS, a positive milestone was achieved for the Baghdad metro when the JV raised the required performance bond and bank guarantees, which will be submitted to the relevant authority. Approval, which HSS expects in end-Nov 24F, will pave the way for the advance payment to be received by Dec 24F.

So far, HSS and its JV partner have billed the client 10% for the first milestone payment (to be recognised in 3Q24F) and a further 15% will be billed by 4Q24F. This contract is important for HSS as it contributes 35% of its total orderbook of RM2.1bn as at Nov 24, has superior GP margins of 40% (vs. local jobs' c.30%) and enables it to diversify out of its MRT 3 PMC contract, on which there has not been clarity regarding the award of the civil portions. A positive catalyst to watch out for is the formalisation of another Iraq project by 4Q24F, i.e. the Naja-Karbala rail project worth US$5.35bn, where the house estimates the total PMC and CSS fees to be c.RM211m.

Reiterate Add with an unchanged TP of RM1.48
CGS is adjusting its FY24F/FY25F/FY26F EPS by -21%/+1%/+4% to factor in lower-than expected contribution from MRT 3 PMC but compensated by faster recognition of Baghdad metro coupled with adjustment in recognition of its existing orderbook.

The blended GP margin assumptions for FY24F/FY25F/FY26F are 31%/28%/28%, which are deem conservative as GP margins for the past 10 quarters were 30-37%. CGS reiterates its Add rating for its capex-light business model and its positioning at the front of the construction value chain with an unchanged DCF-based TP of RM1.48 (WACC: 9.6%, TG: 4.5%, Rf 4%, COE of 11%). Rerating catalysts include receipt of the advance payment for its Baghdad metro contract and faster awards of MRT 3 and other projects while delays in these processes and foreign country risk present downside risks.