KNM Group Bhd - 3Q12 Analyst Briefing Brief

We attended KNM’s 3Q12 analyst briefing yesterday and obtained updates on the company’s current outlook for its geographical segments, its mostrecent order and tender book figures and also the status of its Peterborough project and Borsig listing. On the overall, we believe that our forecasts are still reflective of the near-term prospects of the company and hence are leaving them unchanged. We continue to be neutral on the stock at this juncture. The needed key turning points in our view are 1) a sustainable earnings improvement in all its divisions into 2013 and 2) a meaningful commencement of the Peterborough project. Until then, we are maintaining our MARKET PERFORM call and target price of RM0.53 based on 9.0x CY13 PER.

Turnaround for Asia and Oceania but Americas continues to be a drag. For the YTD, the Asia and Oceania divisions posted sustainable improvements on the back of 1) lower low-margin legacy contracts that were phased out in FY12 and 2) cost optimisation measures, which led to better overall group margins. However, the earnings in the Americas segment continued to be a  drag due to its low capacity utilisation rates. Management guided that KNM will embark on a study to ascertain the necessary cost optimisation strategies for Brazil, although it is still positive on its future prospects here given the high level of activities expected from Petrobras’. For its Canadian operation, the company guided that its ongoing oil sand projects here are doing fine. On the overall, KNM expects an improved 4Q12 performance and is aiming to deliver a profitable set of full-year results (versus the loss saw in FY11).

Order book slightly lower at RM4.7b… The order book has shrunk slightly from the RM5.1b mark in 2Q12 as KNM had adopted a more conservative approach in regards to its project selections to ensure that there would be no recurrence of its 2011 setback. The order book is still largely dominated by Renewable & Green Energy projects (60% contribution) but also includes the Orizon Wte project (Octagon Consolidated), which has yet to see any further developments. Excluding the Peterborough (RM2.1b) and Orizon (RM0.7b) projects, KNM’s core products account for RM1.9b of the order book. 

… tender book higher at RM19b. The tender book has increased from RM16b in 2Q12 due to the company targeting a market expansion and the emergence of new global projects. The tender book is largely skewed to the ‘Plant and technology’ and ‘process equipment’ bids, which accounted for 50% and 48% respectively of book size above. Note that the tender book above, however, does not include both the RAPID and Brazil projects, which management is optimistic on. Hence, the tender book size is likely to grow further in the future.   

Delay of financial close for Peterborough. The main reason for the delay is that the financiers are still discussing the finer details of the power purchase agreement (PPA) that will come into place after the plant has commenced. The construction phase is estimated to take around 44months. To recap, Phase 1 of the project is worth GBP233m of which GBP187m will be debt financed. The arrangers of the debt include EXIM Bank, which is looking to finance c.GBP60m of the debt. The remaining financiers are international banks. 

Status quo on Borsig listing. Management is targeting for the listing to take place in 3Q2013. 

Forecasts. Management is guiding for GP margins of around 18% for FY12 with an improvement to 20% in FY13. This is close to our FY12-13 GP margin assumptions of 18-19%. Hence, we are keeping our forecasts unchanged at this juncture. 

Maintain Market Perform. We continue to be neutral on the near-term prospects of the stock but could potentially upgrade our view in the event of 1) a significant improvement in earnings heading into 2013, 2) a meaningful commencement of the Peterborough project and 3) an improved order book replenishment when both the RAPID and Brazil projects trickle in. Our fair value of RM0.53/share is based on 9.0x PER on CY13 core EPS of 5.9sen while the targeted PER is at discount to the sector average of 15x due to the risk in the earnings of KNM. The risks include 1) a continued delay in its projects and 2) a lower-than-expected improvement in margins and net profits.

Source: Kenanga