This article first appeared in The Edge Financial Daily on October 31, 2017 - November 6, 2017

HSS Engineers Bhd
(Oct 30, RM1.17)
Maintain buy with an unchanged target price of RM1.34: HSS Engineers Bhd has proposed a one-for-10 rights issue of new shares to raise up to RM31.9 million with issuance of bonus issue shares at one-for-two rights shares and free warrants at three-for-two rights shares subscribed. HSS has also proposed a private placement of new shares to raise up to RM52.3 million. The equity issuance is to part-finance the acquisition of SMHB Engineering for RM270 million, which was highlighted in our previous report. We recommend subscribing to the rights issue as earnings per share (EPS) will be enhanced by 53% (based on the maximum-case scenario) post-acquisition and existing shareholders will be entitled to the issuance of bonus shares and free warrants.

The purchase consideration for SMHB will be funded by bank borrowings (RM81 million) at a 6% interest rate, a private placement and a rights issue (RM81 million), and the issuance of new HSS ordinary shares at RM1.14 per share (RM108 million) to the vendors of SMHB. For the RM81 million cash settlement, effectively, every 20 existing shares held by shareholders are entitled to two rights shares with one bonus share and three free warrants. The rights issue is sweetened with free bonus and warrants where only existing shareholders are entitled, and not for private placement subscribers.

On a pro forma basis, HSS’ net profit for financial year 2016 increased by 71% to RM38 million, after excluding investment income for SMHB (RM4 million) and interest expense (RM5 million) on RM85 million of new bank borrowings to part-finance the acquisition. This also excluded the corporate exercise expenses of RM7 million. Its combined order book would increase by 85% to RM738 million post-acquisition. HSS’ net profit margin will likely to be enhanced, given SMHB’s higher net profit margin of 28% compared with HSS’ 10% in the latest audited financial figures.

We believe the acquisition will be earnings-accretive. Based on the maximum-case share issuance scenario and indicative prices of RM1 for the rights issue and private placement and RM1.63 exercise price for warrants, HSS’ EPS would be enhanced by 53% post-acquisition. Net gearing will increase to 0.16 times from an existing net cash position. — Affin Hwang Investment Bank Bhd, Oct 30