[Into the Stocks] Hyundai Construction, Despite Bond Calls... Breaks Out of Stagnation Phase in Second Half

Sudden Bond Call by Singapore Marina South Mixed-Use Development Client
Already Achieved 81.3% of Annual Order Target... Performance Expected to Translate into Results from Second Half

[Asia Economy Reporter Gong Byung-sun] Hyundai Engineering & Construction recorded an earnings shock in the second quarter of this year due to a sudden loss. However, the consensus among securities firms is that this is a one-off adverse event and attention should be paid to the performance that will be realized from the second half of the year.

According to the Korea Exchange on the 27th, Hyundai Engineering & Construction recorded 55,400 KRW, up 2.59% (1,400 KRW) from the previous trading day as of 11:25 a.m. that day. After the second-quarter earnings of this year were announced on the 23rd, the stock price fell 5.76% over two days but is now recovering.

Hyundai Engineering & Construction recorded an earnings shock in the second quarter. Its second-quarter earnings significantly missed market expectations (consensus). The second-quarter sales decreased by 3.5% year-on-year to 4.3835 trillion KRW, and operating profit fell by 8.4% to 141 billion KRW during the same period. These figures are 3.7% and 36.4% below the consensus of 4.5505 trillion KRW and 221.8 billion KRW, respectively.

Sudden 80.9 billion KRW bond call... High possibility of reversal

Marina South Mixed-Use Development in Singapore (Source: Hyundai Engineering & Construction)

The reason Hyundai Engineering & Construction recorded an earnings shock was due to an unexpected loss being reflected. The client of the Singapore Marina South mixed-use development, completed three years ago, exercised a bond call (contract performance guarantee recovery) worth 80.9 billion KRW. A bond call means that a financial institution, which provided a guarantee for a large construction project, pays the guaranteed amount to the client due to the construction company's breach of contract. In other words, the surface reason is that Hyundai Engineering & Construction, as the contractor, did not properly fulfill the existing contract. As a result, 80.9 billion KRW was deducted at once from Hyundai Engineering & Construction's overseas sales.

However, securities firms interpret that the bond call by the Marina South client is a one-off event and will soon be reversed. During the Marina South development, the client frequently changed the design, causing construction costs to exceed expectations, and Hyundai Engineering & Construction filed a claim requesting an increase in the contract amount due to the client's fault. In response, the Marina South client resorted to the bond call. After the completion, a final completion certificate signaling the end of the project is issued when the three-year defect repair period ends, and just before this, the client attempted to nullify Hyundai Engineering & Construction's claim. Lee Seon-il, a researcher at BNK Investment & Securities, explained, "If Hyundai Engineering & Construction withdraws the claim, the client will also cancel the bond call," adding, "The 80.9 billion KRW is likely to be reversed in a later quarter, increasing profits by that amount."

Second half of the year when performance translates into results... Housing supply drives growth

Securities firms are focusing on Hyundai Engineering & Construction in the second half of the year. This is because the sales and order achievements in the housing and overseas sectors will translate into actual results. Hyundai Engineering & Construction secured orders worth 11.4 trillion KRW in the first half alone, already achieving 81.3% of the annual target of 14 trillion KRW.

In particular, the domestic housing supply sector is driving growth. Of the 9.8 trillion KRW in domestic orders, 8.1 trillion KRW came from housing. The cumulative housing supply in the first half reached 14,400 units, accounting for 45.2% of the annual target of 31,938 units. If the housing supply target is met this year, the annual supply volume will increase by 61.1% compared to the previous year, which is a level that increases by 58.4% on average over two years.

Ra Jin-sung, a researcher at KTB Investment & Securities, explained, "The housing business strategy was revised from focusing on urban maintenance to expanding the proportion of general contracting, and project sites judged to have low risk were targeted with project financing (PF) business to simultaneously aim for construction margins and development profits." He added, "This strategy led to development projects through active land acquisition such as the Gayang-dong site and hotel sites." PF refers to a financial structure where banks and other fund providers decide on loans based on the project's cash flow and recover the invested principal and profits. For construction companies, this means less concern about funding and the ability to secure land.

Overseas projects ordered in early last year will also be in full swing from the second half of the year. Last year, Hyundai Engineering & Construction secured orders for a 2 trillion KRW oil refining project in the Basra region of Iraq and a 1.7 trillion KRW Panama metro project, both of which started construction normally in the first quarter. Researcher Ra said, "The overseas project progress, which will be in full swing from the second half, will lead to increased sales and improved profitability," adding, "The order environment in the Middle East, which had been sluggish due to COVID-19 and low oil prices, is also recovering."

Despite the second-quarter earnings shock, most securities firms did not change their 'buy' investment opinions or target prices for Hyundai Engineering & Construction. Shinhan Investment Corp. maintained a target price of 75,000 KRW, KTB Investment & Securities 73,000 KRW, Hanwha Investment & Securities 72,000 KRW, NH Investment & Securities 70,000 KRW, BNK Investment & Securities and DB Financial Investment 67,000 KRW, and Kyobo Securities 60,000 KRW.