KNM Group - Rebound from order recognition, but rights pending Hold

- We upgrade our call on KNM Group to HOLD from SELL as the share price has fallen near our unchanged fair value of RM0.75/share, pegged to an FY12F PE of 15x – slightly below the oil & gas sector’s 16x. 

- KNM’s 1QFY12 net profit of RM35mil came in above expectations, accounting for 46% of our FY12F and street estimates. But our FY12F-FY14F net profits are maintained for now, as we understand that there could be some writeback of provisions over the past year. Moreover, given the group’s past erratic earnings performance, we prefer a more conservative stance, pending a longer track record of sustainable quarterly profits. We note that the group’s chief financial officer has resigned.

- Despite a flat QoQ revenue growth, KNM rebounded to a pre-tax profit of RM16mil in 1QFY12 from a loss of RM11mil in 4QFY11, which had suffered from cost overrun provisions of RM30mil. We understand this turnaround came from margin improvements for ongoing projects.

- KNM’s current order book stands at RM5.3bil and I it tendering for up to RM16bil potential orders. But over half the order book comprises:- (1) the US$600mil (RM3bil) Peterborough Renewable Energy Ltd (PREL) project, and (2) the US$248mil (RM769mil) waste-to-energy Sri Lankan project from Octagon Consolidated, which have yet to secure external funding amid an absence of clarity  in project commencement.

- We understand that the group plans to use the proceeds from the recently proposed rights issue of up to RM200mil for the above two projects. But this could mean a dilution in FY13F EPS of up to 12% with a 28% expansion in share capital, based on the current stock price. 

- KNM has recently renewed its option agreement to acquire a 55-acre vacant land for the Peterborough Renewable Energy Ltd (PREL) project. With the land ownership, we understand that KNM could possibly end up with an 80% stake (with the balance held by UK-based sponsors) in this waste-to-energy concession if the group could secure external borrowings. Additionally, KNM may also end up with a 51% stake in the Sri Lanka waste-to-energy project.

- This may be a negative development as we estimate that the huge projects could elevate the group’s current net gearing level of 0.5x to a worrisome 2.3x (assuming a successful rights issue), unless other investors dilute KNM’s equity stake to an associate level. 

- Normalising tax rates for the group’s positive charge stemming from capital allowances (which expire in 2013) arising from the acquisition of Borsig, KNM currently trades at a pricey FY12F PE of 21x, way above the oil & gas sector’s 16x. This is unjustified given KNM’s erratic quarterly earnings delivery over the past three years.

Source: AmeSecurities