Investment Highlights

• We cut our FY18-20F net profit forecasts by 3%, 14% and 25% respectively, reduce our FV by 13% to RM1.13 (from RM1.30) based on 9x revised FD FY19F EPS, in line with our benchmark forward target PE of 7-10x for small-cap construction stocks. Downgrade our call to UNDERWEIGHT from HOLD.

• We came away from a small group meeting with the company yesterday feeling even more cautious on its outlook. We got the impression that the company is in “safe mode” where credit risk management takes precedence over growing its earnings. We believe the company has read the market (the unfavourable outlook of the local construction sector) correctly and is doing the right thing.

• However, this may also mean the share price upside will be capped over the short term, in the absence of earnings growth. Our earnings downgrade is largely to reflect Kimlun’s conscious decision to focus on projects backed by clients with strong credit standing. These “safe” projects typically command lower margins.

• Kimlun moderated its guidance for potential construction job wins in FY18F to RM600-800mil (from RM600-900mil prior to the 14th General Election), which is still consistent with our assumption of RM700mil annually in FY18-20F. YTD, it has secured new jobs worth a total of RM400mil comprising largely private-sector infrastructure works (such as land clearing, roads and an interchange) as well as private-sector property projects (largely those with products priced at below RM500,000 per unit).

• Kimlun is confident of securing more similar privatesector building jobs from some “strong names” (reputable developers) before the year is out. At present, its outstanding construction order book stands at RM1.7bil that should keep it busy over the next two years.

• We see better earnings visibility at its precast concrete product division that contributed to 20-40% of group profits in FY16-17. This is because the depleting new orders locally (arising from the cancellation of various mega infrastructure projects), should be cushioned by those from Singapore driven by new infrastructure projects such as the North-South Corridor Expressway and Jurong Region Line, which are largely elevated (that requires segmental girder boxes (SGB)) and underground (that requires tunnel lining segments (TLS)).

• YTD, the division has secured new orders worth a total of RM163mil, of which 80% coming from Singapore comprising TLS for the Circle Line extension and North-East Line, and pre-cast concrete building components for a high-tech manufacturing plant. At present, its order backlog stands at RM400mil that should also keep it busy over the next two years.

• We remain cautious on the outlook for the local construction sector. As the government scales back on public projects, local contractors will be competing for a shrinking pool of new jobs in the market. Severe undercutting among the players will result in razor-thin margins for the successful bidders. On the other hand, the introduction of a more transparent public procurement system under the new administration should weed out rent-seekers, paving the way toward healthier competition within the local construction sector.

• At about 10x its forward earnings on muted growth prospects, we believe the share price upside is capped for a small-cap construction stock like Kimlun.

Source: AmInvest Research - 21 Sept 2018