Kelington’s (KGB) 3Q19 earnings missed estimates as its Singapore project saw a delay, as well as a lower-margin revenue mix. With 4Q being seasonally its strongest quarter, KGB will likely see a stronger pick-up from the delay. We cut 2019-21E EPS by 10-11% to reflect lower margins and our more cautious China order book replenishment outlook. We maintain our Buy rating after raising our target PE multiple to 17x (from 16x), reflecting the group’s long-term strategy as an industrial gas player as the LCO2 plant commence operation.

Missed Expectations on Weaker Margin

KGB’s 3Q19 headline net profit grew 35% yoy to RM6.3m. Stripping out the RM2m receivable write-backs, core profit came in lower at RM4.3m (-34% yoy), bringing 9M19 core profit to RM14.2m (-2% yoy). 3Q19 results missed our and consensus expectations on two fronts: i) delayed work in a major Singapore UHP project, now guided to be completed by February 2020, and ii) gross profit margin slipped due to a low-margin revenue mix. As a result, 3Q19 saw a temporary dip in gross margin at 12.5%, compared to 1H19’s average margin of 17%.

Outstanding Order Book at RM282m

KGB secured an additional RM67m of contracts in 3Q19, bringing year-todate new wins to RM294m (69% of FY19 replenishment at RM424m). This brings KGB’s current outstanding order book to RM282m (2Q19: RM312m). We cut our FY19 EPS forecast to factor in the project delay and lower our gross profit assumption to 15.7% (from 16.5%). Although receivable writebacks will likely normalize in 4Q19, we are expecting a stronger pick-up in work progress following the 3Q delay. We also lower our FY20-21E profit by RM3-4m to factor in a lower gross margin at 16.6% (previously 17%) and likelihood of a slower China backlog replenishment as a result of the prolonged trade war.

Maintain BUY With TP of RM1.60

With the LCO2 plant commencing operation, we raise our 2020E target PE multiple from 16x to 17x, +1SD above its historical 5-year mean, and a 15% discount to its current global industrial gas peers’ valuation to reflect its new profile. With our earnings cut, we lower our TP to RM1.60 (from RM1.68). Key downside risks to our call include a slowdown in the semiconductor sector, increased price competition, and a breakdown in trade negotiations between the US and China.

Source: Affin Hwang Research - 20 Nov 2019