Journey to Wealth
Kelington Group - An Integrated Player With Lofty Aims
We like Kelington's future prospects in view of its aspirations to transform itself into a one-stop total facilities solution provider. The company's strong relationships with various reputable gas and chemical companies also appeal to us. We value Kelington at RM1.50/per share, based on a 5.7x FY13 EV/EBITDA. At the current share price, our FV offers a potential upside of 30%, making the stock a solid investment proposition. Its re-rating catalysts are: (i) winning sizeable jobs, (ii) better profit margins, and (iii) M&A initiatives.
Company at a glance. Kelington is a leading Ultra-High Purity (UHP) gas and chemical delivery solutions provider with a presence in Malaysia, China, Taiwan and Singapore. It has formed partnerships with various multinational specialty gas/chemical providers to implement mission-critical UHP delivery systems in high-technology industries. Its services are well sought after by companies in the wafer fabrication, flat panel display (FPD), solar energy, pharmaceutical, light emitting diode (LED) and storage media industries.
Serves growing high-tech industries. There is room for growth in the global solar photovoltaic (PV) electricity market despite deep cuts in incentives in countries like Germany and Italy. We believe that continuous education worldwide on renewable energy will enhance awareness and demand, especially in under-penetrated regions. In the global semiconductor market, clear signs of recovery are emerging after the 8.9-magnitude earthquake that struck Japan early last year. We believe the demand for smartphones and tablets would perk up growth in the sector going forward. We also expect the same catalyst to drive the expansion of the thin film transistor liquid crystal display (TFT-LCD) market.
A record of solid financials. We are impressed with Kelington's top-line growth over the past 4 years of a CAGR of 25%, fuelled mainly by its overseas operations. However, its core PAT only grew at a slower 4-year CAGR of 20%, owing to the increase in the number of low-margin overseas projects. That said, we draw comfort from the fact that Kelington has been in net cash for the past 6 years. The company's overall free cash flow per share from 2006-2011 has been within the 4 to 13 sen range, which enabled it to distribute dividends of 2 to 3.5 sen since going public in 2009. With its coffers and equity building up y-o-y, we are not ruling out the possibility of the company declaring a larger dividend payment or capital distribution in any form. Recently, Kelington announced a policy of paying out 25% of its PAT.
COMPANY BACKGROUND
Established in 2000, Kelington is a leading Ultra-High Purity (UHP) gas and chemical delivery solutions provider with regional footprints in Malaysia, China, Taiwan and Singapore. Throughout the years, Kelington has formed partnerships with multinational specialty gas/chemical providers to implement mission-critical UHP delivery systems in high-technology industries. Its services are well sought after by companies from the wafer fabrication, flat panel display (FPD), solar energy, pharmaceutical, light emitting diode (LED) and storage media industries. According to Frost & Sullivan, Kelington commands a share of about 23.3%/1.8%/1.4% of the markets in Malaysia/China/Taiwan respectively in terms of revenue.
Kelington's services can be categorized in three segments:
i) Base build ' 'Backbone' of the UHP delivery system which connects gas and chemical sources which are to be distributed throughout a high-technology manufacturing plant.
ii) Hook-up and maintenance ' 'Last-mile' of the UHP delivery system which connects the base build to primary and process tools. The company also provides regular maintenance and technical support services.
iii) Others ' Trading of materials and other ancillary testing, installation and commissioning works.
Competent management. Mr Gan Hung Keng, CEO, and Mr Ong Weng Leong, COO, are the two key personnel driving Kelington's business forward. Mr Gan and Mr Ong ' who were previously with MOX - each have 15-20 years of experience in the field. Their expertise and technical know-how in UHP systems design have enabled the company to rope in a host of prospective customers. We understand that customers are willing to pay a premium for the installation of reliable UHP systems at their facilities because they often deal with hazardous gases/chemicals. Note that Mr Gan and Mr Ong each has a 13% effective controlling stake in Kelington via their respective 27% shareholdings in Palace Star SB.
An expanding business. In February, Kelington acquired Singapore-based Puritech Technologies Pte Ltd for SGD2.1m to expand into exhaust delivery systems. We understand Puritec was only set up in May 2011 and it is still in the gestation period. However, this phase is expected to be short-lived given that the company is run by a group of veterans formerly with Envipure, which is Kelington's competitor. Kelington revealed that Envipure generates average revenue of SGD60-70m annually, with a market share of 70%. Assuming that Puritech succeeds in capturing a 10% market share from Envipure, the former will generate a top-line of SGD5-10m. Management has indicated its intention of tapping into the delivery systems of other utilities, i.e. the water and vacuum segments in the near term, which could transform the company into a one-stop total facilities solution provider.
BUSINESS OUTLOOK
Not all doom and gloom for PV market. There is room for the global solar photovoltaic (PV) electricity market to grow despite deep cuts in incentives in countries like Germany and Italy, both of which have a combined global market share (in terms of PV installations) of approximately 57%. We believe that continuous education on worldwide renewable energy will enhance awareness and demand, especially in under-penetrated regions. According to the European Photovoltaic Industry Association (EPIA), the PV market will grow in a more sustainable manner riding on the competitiveness of PV solutions rather than by financial support schemes. Recently, Japan turned to solar PV electricity as a long-term energy solution after the nuclear meltdown last year, and will implement next month a feed-in-tariff (FiT) with a generous payout of JPY42 per kWh to stimulate the country's solar energy investment. The local government hopes to add 3.2 gigawatts (GW) of solar energy to its domestic electricity grid, replacing the power generated by the nuclear industry (which supplies 21% of Japan's energy needs). Should demand outpace supply in the future, we expect Kelington to be involved in the setting up of new solar PV plants in China ' currently the world's leading PV module producer - to meet global shortages.
Worst is over for global semiconductor market. The global semiconductor market is finally showing signs of recovery in the wake of last year's 8.9-magnitude earthquake that struck Japan. According to the Semiconductor Industry Association (SIA), worldwide sales ticked up by a mere 0.4% y-o-y to a record USD299.5bn in 2011. Based on its most recent report, worldwide semiconductor sales improved by 3.4% m-o-m in the month of April to USD24.1bn, representing the second consecutive month of growth and also the fastest growth rate in 2 years on a m-o-m basis. We are encouraged by the positive figures and expect growth for the rest of the year, mainly fuelled by smartphones and tablets, while the demand for other products will remain muted due to global economic uncertainties. Meanwhile, the book-to-bill ratio for semiconductor equipment manufacturers remained above equilibrium for the fourth consecutive month in May, as reported by the Semiconductor Equipment and Materials International (SEMI). The overall full-year growth for 2012 should be flat, given the fact that for the first four months, global sales had already contracted by 6.7%. Going forward, World Semiconductor Trade Statistics (WSTS) forecasts the worldwide semiconductor market to grow at 7.2% to USD322bn in 2013, followed by a 4.4% growth to USD336bn in 2014.
Revenue to grow with stabilizing margins. We were impressed with Kelington's top-line growth over the past 4 years with a CAGR of 25%, thanks mainly to its overseas operations. Although management has successfully enlarged its market share, this took place at the expense of its bottom-line. Core PAT only grew at a 4-year CAGR of 20%, which is slower than that for revenue, given the increase in the number of low-margin overseas projects. However, we expect the gross profit (GP) and core PAT margins to normalize from FY12 onwards, since it does not make sense for Kelington to continue being aggressive in capturing market share, especially with its core PAT margin being very thin at 6%.
1Q results acceptable. Kelington reported 1QFY12 revenue of RM26.7m (-41% q-o-q, +38% y-o-y) and core PAT of RM0.8m (-74% q-o-q, +2% y-o-y). At first glance, q-o-q numbers appear to be disappointing but in fact seasonality factors were behind the poor financial performance. Looking at historical trends, 1Q tends to be the weakest quarter, typically representing only 15%-20% of total revenue and core PAT for a particular year. On the positive side, its financial performance improved y-o-y while its q-o-q GP margin remained at 15%. Nevertheless, its core PAT margin fell 370 bps q-o-q to 3%, but we expect this to improve over the next 3 quarters, in line with the historical trend.
Solid balance sheet. We also draw comfort from the fact that Kelington has been in a net cash position for the past 6 years since 2006. Cash flow from operating activities during the period was robust, consistently being in the black with the exception of 2010, during which its working capital experienced a decline due to an increase in credit sales for that year. The company's overall free cash flow per share from 2006-2011 has remained strong within the 4'13 sen range, enabling it to distribute dividends of 2'3.5 sen since going public in 2009. With its coffers and equity increasing on a y-o-y basis, we are not ruling out the possibility of a larger dividend payment or capital distribution in any form. Recently, Kelington has announced a dividend payout policy of 25% from its PAT.
INVESTMENT MERITS & RISKS
Investment merits
Transforming into a one-stop total facilities solution provider. As explained, Kelington now has exposure to the exhaust segment with the recent acquisition of Puritech. Going forward, management intends to venture into the water and vacuum segments to diversify its revenue and income streams.
Competitive advantage over its peers. Thanks to its sound safety track record, Kelington managed to gain the confidence of gas and chemical manufacturers as well as companies operating in various industry sectors. As highlighted in page 3, the strong relationships it has with reputable gas and chemical manufacturers also bode well for Kelington, allowing it to enter into partnerships needed for certain projects.
Risks
Lack of long-term contracts. We understand that as of 31 May, Kelington has an outstanding orderbook of RM48m, which could last them for only about 6-9 months. Thus, the short timeframe for its orderbook replenishment is a key risk for the company. Nonetheless, management has identified some RM400m worth of projects for FY12. Based on its historical success rate of 25%, Kelington is poised to replenish its orderbook by RM100m.
Fluctuation in forex and raw material prices. We gather that the cost of steel piping and fittings accounts for approximately 25% of a typical project cost. Given that the steel industry is highly cyclical, any adverse movement in steel prices could be detrimental to Kelington's bottom-line. Even though additional costs could be passed on to its customer, this would come at the expense of competitiveness. Also, with Kelington deriving 69% of its revenue from foreign markets in 2011, it has high exposure to forex risks.
FY12 and FY13 financial forecasts. Assuming Kelington manages to increase its current outstanding orderbook to RM148m, we expect the company's FY12 revenue to grow by 15.5% y-o-y. Given that its GP margin has stabilized at 14%-15% over the past 5 quarters, we foresee a similar GP margin going forward. However, its core PAT margin has been rather volatile, thereby making it difficult to forecast future trends. Even so, we do not expect its bottom-line margin to erode, probably staying at the 5%-6% level and its FY12 core PAT is anticipated to grow by 14.8% y-o-y. For the subsequent year, we expect FY13 revenue and core PAT to expand by 11.8% and 9.6% respectively.
Kelington's stock undervalued with 30% upside potential. Based on 5.7x FY13 EV/EBITDA, we arrive at a FV of RM1.50 for Kelington. This multiple is obtained by ascribing a 30% discount to the simple 3-year historical EV/EBITDA sector average of 8.1x. The 30% discount factors in the illiquidity of the stock as well as an unexciting tech sector in Malaysia. At the current share price, our FV offers a potential upside of 30% and hence, makes for a solid investment proposition. All in all, we like Kelington's future prospects in light of its aspirations to become a one-stop total facilities solutions provider.
Source: OSK
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