AI Data Center Engine Demand Will Drive Long-Term Upside Potential

Catalysts

About Hong Leong Asia

Hong Leong Asia is a diversified industrial group with businesses across building materials, diesel engines, and related manufacturing operations.

What are the underlying business or industry changes driving this perspective?

• Growing global demand for high horsepower engines used in AI data centers and power generation supports volume and pricing for the engine business, which can have a direct impact on revenue and operating profit.
• Ongoing investment in engine technology, including alternative fuels and range extender systems, positions Hong Leong Asia to participate in tightening emissions standards and new powertrain requirements, which can influence gross margins as higher value products scale.
• Capacity expansion for high horsepower engines through process redesign and outsourcing of machining creates a path to higher unit throughput with a lighter balance sheet footprint, which can affect asset turns and earnings resilience through industry cycles.
• Diversification across on road, off road, marine, and power generation engines reduces reliance on any single end market and can smooth revenue and net margin performance when specific sectors experience volatility.
• Equity interests in engine related technology and component suppliers, along with participation in funds focused on new technologies, may deepen the engine ecosystem around the group and support long term earnings through both operating contributions and associate or joint venture income.

Assumptions

How have these above catalysts been quantified?

• Analysts are assuming Hong Leong Asia's revenue will grow by 10.2% annually over the next 3 years.
• Analysts assume that profit margins will increase from 2.2% today to 3.1% in 3 years time.
• Analysts expect earnings to reach SGD 212.8 million (and earnings per share of SGD 0.27) by about August 2029, up from SGD 112.9 million today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting SGD278.8 million in earnings, and the most bearish expecting SGD182.9 million.
• In order for the above numbers to justify the price target of the analysts, the company would need to trade at a PE ratio of 21.6x on those 2029 earnings, down from 21.8x today. This future PE is greater than the current PE for the SG Machinery industry at 12.1x.
• Analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.85%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• China Yuchai's high horsepower engine capacity is already guided at 5,000 units for 2026, with AI data center sales expected at around 3,500 units for the year. If Hong Leong Asia's associated engine operations cannot keep pace with this kind of capacity build out or face bottlenecks in subcontracted machining, revenue growth tied to AI and power generation demand could fall short and weigh on earnings.
• Management on the call highlighted pricing pressure and discounts at the MTU Yuchai joint venture, which kept gross profit margin above 30% but below revenue growth. Sustained competition or further discounting in high horsepower engines could limit Hong Leong Asia's ability to translate volume growth into higher net margins and profit.
• China Yuchai is increasing R&D and SG&A spending, with total R&D expenditures reported at RMB 622.5 million and SG&A at RMB 1.1b in first half 2026. If Hong Leong Asia's related engine businesses follow a similar spending trajectory without a matching uplift in pricing or mix, operating margins and overall earnings could come under pressure.
• Some long term technology bets highlighted on the call, such as fuel cell systems for power generation and North American gas engine certifications, are still in progress and not yet contributing. If similar projects at Hong Leong Asia take longer than expected to reach commercial scale, returns on invested capital could stay subdued and weigh on valuation multiples and earnings growth expectations.
• China Yuchai's results show exposure to multiple end markets, with agricultural machinery engines declining 18.9% year over year even as trucks and marine and power generation grew. If Hong Leong Asia faces a similar pattern where one or more segments weaken while others grow, the consolidated revenue and net margin profile may be more volatile than a simple AI or data center growth narrative suggests.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The analysts have a consensus price target of SGD4.89 for Hong Leong Asia based on their expectations of its future earnings growth, profit margins and other risk factors.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of SGD5.5, and the most bearish reporting a price target of just SGD4.28.
• In order for you to agree with the analysts, you'd need to believe that by 2029, revenues will be SGD6.9 billion, earnings will come to SGD212.8 million, and it would be trading on a PE ratio of 21.6x, assuming you use a discount rate of 7.9%.
• Given the current share price of SGD3.08, the analyst price target of SGD4.89 is 37.1% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.