KNM Group Bhd - New Joint Venture

News    KNM Group Bhd (KNMG) announced that it had entered into a shareholder cum joint venture agreement with HMS Oil and Gas (HMS) to establish a company known as KNM HMS Energy (KHE).

 KNMG will hold a 70% equity stake in KHE while HMS will hold the remaining 30%.

 KHE will be utilised by the parties to secure opportunities in the upstream oil and gas sector in Malaysia. 

Comments   For now, we are neutral on this tie-up as there was no further guidance by management in regards to the details of the counterparty (HMS) and the nature of the projects that the new JV will be exploring.

 However, based on the announcement, we suspect the company could be looking to acquire assets either to enter the upstream oil and gas services sector (i.e. FPSO/jack-up rig/MOPU) or participate in marginal field bids. We highlight that both these endeavours require a sizeable capex.

 In any case, a move to the upstream sector will be a new business undertaking for KNM.

Outlook   FY12 earnings are expected to be in the black due to: 1) legacy loss-making projects being completed within CY12, and 2) efforts undertaken to improve cost efficiency and productivity.

 Some plant capacity rationalisations are expected as certain plants (e.g. Brazil/Indonesia/Australia) seem to be suffering from low utilisations.

 The Peterborough and Octagon projects are currently in status quo. However, there are targets to secure financing for Peterborough soon.

Forecast   No change to our forecasts at this juncture. 

Rating     Maintain MARKET PERFORM

Valuation    Based on an unchanged targeted PER of 9.0x on CY13 core EPS of 5.9sen, we are maintaining our fair value of RM0.53. 

 While our target price implies a 15.9% upside to current share price, we are keeping our MARKET PERFORM rating given the uncertainty of KNM’s ability to secure funding for its large projects and to sustain the improvement of its existing operations. 

 The discount to the sector’s average PER of 15x is due to the significant earnings risk given KNM’s historical bottom line volatility.

Risks   1) Disappointing forward earnings trend; 2) delay in its larger projects that are imperative for margin improvement; and 3) Lack of experience to successfully kick-start its new business undertakings.  

Source: Kenanga