Being a unique proxy to the global semiconductor front-end players, KGB is set to ride on the fabs’ spending, which Southeast Asia is slated to register record high investments in 2023. With KGB's current orders in hand standing at an all time high of RM1.9bn coupled with higher contribution from the industrial gas segment, we project its core PATAMI to register a strong 25% FY22-24 CAGR. We value KGB at RM1.82/share, ascribing a 21x PE to FY23 earnings.

Ultra-high purity (UHP) solutions provider. Listed since 2009, Kelington Group Berhad’s (KGB) principle operations are segregated into four main business segments, namely (i) UHP delivery system; (ii) general contracting; (iii) process engineering; and (iv) industrial gases. In particular, the UHP segment which encompasses designing and building delivery system for the transmission of ultra -high purity gases (i.e. hydrogen, argon, carbon dioxide, helium and oxygen) for E&E and semiconductor players is the main revenue contributor (65% of FY21 revenue), serving MNC clients such as SMIC, Micron and Osram. These gases are used for semiconductor fabrication – the photolithography and etching processes.

Robust fabs’ expansion to drive UHP segment. Bucking the gloomy headlines of slowing chip demand, KGB's YTD secured orders of RM1.28bn has breached FY21 RM1.19bn record, with current tender book still standing at a robust value of RM1.5bn. Meanwhile, KGB's current order in hand stands at an all-time high of RM1.9bn, implying a cover of 3.67x, thanks to the robust wafer fab investment pipelines. To recap, SEMI is projecting global fab equipment spending to register a +9% and -2% YoY growth to USD99bn and USD97bn in 2022 and 2023, respectively. Bucking the negative growth rate in 2023, Southeast Asia is projected to register a record high investments in 2023 (source). This buoyant outlook is also augmented by the "China+1" strategy, where semiconductor players look for alternative production hubs outside China, nudging strong FDI to Malaysia and Singapore, given their well established semiconductor ecosystem in ASEAN. We believe KGB stands to be the potential beneficiary of the fab projects that were announced in 2022 including SMIC new fab in Tianjin, UMC new fab in Singapore and Dnex-Foxconn JV 12-inch wafer fab in Malaysia.

Growing the industrial gas business. Leveraging on management’s expertise in industrial gas – the founder of KGB was the head engineer at Malaysia Oxygen Berhad (currently known as Linde Malaysia) – KGB ventured into food-grade liquid CO2 (LCO2) gas business in 2017, and the plant was commenced in 2019 in Kerteh. Despite facing hiccups in 2020, LCO2’s plant utilization rate has been growing steadily, from 20% in FY19 to 80% in 1H22. Meanwhile, the recent unscheduled breakdown at competitor’s plants has propelled KGB’s plant to run at even higher utilization rate in Jul-Aug, after securing new F&B customers. Though KGB has yet to ink a long-term supply agreement with the new F&B customers, we reckon a capacity expansion is on the cards, judging from the current high utilization rate and limited spare capacity to cater for additional contracts. Separately, the RM180m 10-year supply scheme that was secured in 2Q22 will commence in 1Q23. Overall, the industrial gas business provides stable recurring income with a superior margin (industrial gas GPM: 30% vs UHP: 15%).

Forecast. Despite robust fab spending outlook in Southeast Asia, we take a pinch of vigilance in current volatile market by inputting conservative project secured assumptions of RM1.4bn/900m/600m for our FY22/23/24 forecasts. All in, we project KGB’s core PATAMI to register a strong FY21-24f CAGR of 26%.

Fair value of RM1.82, based on 21x P/E to FY23f EPS of 8.7 sen, implying +1SD of its 5-year mean and KLTECH’s FY23f P/E but 30% lower than the 30x P/E we assigned to FRONTKEN – another proxy to the semiconductor front -end players – to reflect KGB’s lower margin and ROE.

Source: Hong Leong Investment Bank Research - 5 Oct 2022