We believe the 23% correction from 52-week high has grossly priced in the earnings vacuum post SPLASH sale, which contributed the lion’s share of KPS profits. Nevertheless, this will be mitigated by the continuous implementation of the Business Transformation Plan to optimise the performance of its investee companies, which has already shown some improvement in 2Q18 results. Downside risk is cushioned by undemanding valuation at 0.6x P/B (on par with 10Y historical average) and potential special dividend (ranging fromRM0.22- 0.42) arising from the SPLASH sale, which will transform KPS into RM312m net cash from RM453 net debt in 2Q18.

Company profile: Post disposal of 30% stake in Splash in Sep 2018, KPS (the flagship public-listed corporation of the state of Selangor with ~63.4% stake) will focus investment in six core sectors namely manufacturing (Century Bond packaging, CPI Electronic Manufacturing Services player, King Koil manufacturing), trading (water treatment chemicals), licensing (King Koil international licensing), infrastructure and utility (rehabilitation of water, sewerage, maintenance of pipeline assets, general civil engineering works, building construction and maintenance), oil and gas (liquefied petroleum gas services), as well as telecommunications.

Manufacturing division to drive earnings growth. Post SPLASH disposal, KPS is entering a new era of earnings diversity and its reach has extended to new frontiers globally (mainly from the manufacturing segment), where revenue from overseas will make up approximately one-third of the group’s revenue. Furthermore, these companies have proven expertise in their respective fields, with capacity to extend their lead and command strong double-digit margins. This bodes well for KPS’ earnings quality and ability to generate increasing returns for shareholders. In 1H2018, the manufacturing divisions contributed 54% to revenue at RM146m. To recap, the business expansion of its subsidiary Century Bond is expected to contribute to higher earnings for the group in the FY18. As for Century Bond, the group is seeking to further enlarge the subsidiary's footprint in the non-cement sector in Malaysia. The recently-signed joint venture between Century Bond and China based Honda Printing Holdings Limited (Honda Printing) to produce offset carton boxes, enables Century Bond to extend its value-chain further into offset carton boxes, where the outer layer of the box is laminated by a printed sheet to provide finer and more vibrant printing.

Meanwhile, its acquisition of electronic manufacturing solutions (EMS) player CPI (Penang) Sdn Bhd (completed in 1Q18), will also be immediately value-accretive to the group's consolidated FY18 revenue. CPI's global clientele spans across the automotive, healthcare, telecommunications, as well as industrial and consumer industries, where 50% revenue is derived from exports, while local sales are primarily to Malaysia-based subsidiaries of multinational groups. The price tag for CPI was RM250m, inclusive of a profit after tax guarantee of RM51m, consisting of RM25m in FY2018 and RM26m in FY2019. KPS has also set a new direction for its King Koil licensing business for the US market, by setting its first manufacturing plant in Arizona, Phoenix for direct distribution in the Western region of the US. It has also formed a strategic partnership with Blue Bell Mattress to manufacture and distribute King Koil products in US' Midwest region. The new direction will enable the group to command greater control of the distribution and product quality, and grow market share in King Koil’s home ground in the US.

KPS will receive a total of RM765m cash proceeds (30% stake) from SPLASH sale. Air Selangor would be acquiring SPLASH in a RM2.55bn cash deal, comprising an upfront payment of RM1.9bn, with the remaining RM650m paid over nine equal annual instalments at an interest rate of 5.25% pa. The consideration of RM2.55bn suggests a 28% discount to SPLASH’s Jun 2018 NAV of RM3.54bn. KPS, which owns 30% of SPLASH, is expected to receive a total RM765m cash proceeds (upfront cash RM570m or about RM1.06 per share with the remaining RM195m to be paid in instalments over a period of nine years). This will transform KPS to RM312 net cash from RM453m net debt as at end June 2018. SPLASH and Air Selangor are expected to finalise the terms and conditions of the SPA by 14 Sep 2018. As SPLASH is an associate company of KPS, the acceptance of SPLASH takeover offer does not require approval from KPS shareholders. Overall, the acquisition of SPLASH by Air Selangor is undertaken as part of the consolidation and restructuring of the water industry in Selangor, Kuala Lumpur and Putrajaya by the state and federal governments.

Special dividend soon? Despite remaining silent on any special dividends announcement after accepting the deal in Aug, we still believe KPS will distribute part of its cash proceeds from sale as special dividends to reward its loyal shareholders, with the state of Selangor holding about 63.4% stake. To recap, KPS paid out a special dividend of RM99m or 46% from the total proceeds of RM213m in Oct 2013 following the completion of disposal of its 56.57% stake in Kumpulan Hartanah Selangor Bhd (KHSB) to Kumpulan Darul Ehsan Bhd (KDEB) in Sep 2013. For conservative approach and assume a 40% distribution from the RM570m cash upfront (rather than using RM765m), shareholders can expect a 42sen bumper special dividend. On the other hand, even after deducting total net debt of RM453m in 2Q18, we still can expect at least RM117m or 22sen per share to be distributed. Hence, given the potential special dividend ranging from 22-42 per share, this will translate into a whopping yield of about 13.9%-26.5% based on KPS’ closing price of RM1.58.

Potential downtrend channel breakout. After correcting 23% from 52-week high of RM2.06 (23 Jul 2018) to RM1.58 (13 Sep), KPS is likely at the tail end of a downward consolidation, reflected by the hammer and while candlesticks pattern in the last two days, accompanied by mild hook-up in indicators. A decisive cross above RM1.63 (upper downward channel) hurdle will spur prices higher towards RM1.73 (38.2% FR) before reaching our LT objective at RM1.86 (23.6% FR). Supports are RM1.52 (61.8% FR) and RM1.46 (lower downtrend channel). Cut loss at RM1.45

Source: Hong Leong Investment Bank Research - 14 Sept 2018