KNM Group Bhd - UNDERPERFORM - 23 May 2012

Period    1Q12

Actual vs. Expectations

 Profit before tax (PBT) of RM16m was marginally below the mark, accounting for 18% of our expectations (RM87m). However it was within the consensus’ PBT estimate (RM124.1m) at 25%. 

 Variance to our estimate is likely mainly due to lowerthan-expected margins on the projects executed within the quarter.

 We review the results on a PBT basis to exclude the impact of the tax credit received in 2009 that skews  KNM’s net profit figures.

Dividends   No dividend was declared.

Key Results Highlights

 YoY, 1Q12 PBT increased (>100%) mainly due to improvements in margins (+1.2ppts) as legacy contracts (contracts won in 2009-10 that had significantly low margins) have been nearly phased out. QoQ, 1Q12 PBT again is overall better off due to healthier margin contracts executed within the quarter. To recap, the earnings trend for most of 2011 was dismal as KNM has implemented projects with sub-par margins only given the stiff competition to win projects in 2009-10.

Outlook   Management is confident FY12E earnings will be in the black as 1) legacy projects are nearly completed and 2) most of the foreseeable losses have already been provided for in 2011.

 We remain cautious as its two of its large projects (Peterborough and Octagon Consolidated) have still not received financing approvals. Hence, any major margin improvement could be delayed.

 Order book is estimated to be around RM5.2-5.3b.

Change to Forecasts

 Our core net profit (ex tax credit) is reduced to RM54.9m as we assume lower margins for the company in FY12E. Net profit will still be buoyed by tax credit but this will expire by 2012. 

 We have introduced FY13-14E net profit of RM81.3m and RM98m which incorporate 1) higher capacity utilisation rates of 75% and 80%; 2) improved EBIT margins of 7.0% and 7.3% (from FY12E of 6%) and 3) an effective tax rate of 20%.

Rating MAINTAIN UNDERPERFORM

Valuation    We have rolled our valuation basis forward to FY13E. Based on an unchanged 9.0x targeted PER on EPS of 8.1sen, we are downgrading our fair value to RM0.73 (from RM0.83). The discount to the sector average PER of 15x is due to the significant risk to earnings. Given the limited upside (+2.6%) to the share price, we are maintaining our UNDERPERFORM call. 

 However, we are inclined to upgrade our view if the company is able stay in the black throughout the next few quarters.  

Source: Kenanga