News     On Monday, KNM (“KNMG”) announced that there were 37.2% deviations between its announced unaudited accounts (RM130.6m) back in Feb-12, and the final audited net profit (RM82.0m) for 31 December 2012. The difference amounted to RM48.6m and is largely caused by impairments relating to KNM’s Brazil business that made up around 74.4% (RM36.2m) of the overall adjustment.

Excluding the tax incentive of RM89m from the new net profit, results in a FY12 core net loss of RM6.9m.

Comments      According to the announcement, the main adjustments were due to the Brazil operating unit being evaluated as unable to generate sufficient revenue on its own.

Within the RM36.2m, goodwill of RM29.6m (attributed to the skills and technical talent of the business acquired in 2008) has been fully impaired during the year, whilst the remaining pertains to impairments of deferred tax assets and property, plant & equipment and provisions for contingency cost.

Whilst we had expected some plant capacity rationalisation exercises for KNM’s Brazil business (mentioned in our 4QFY12 results note), we were negatively surprised by the significant value.

Outlook     Besides Brazil, we believe that there are other plants (i.e. Indonesia and Australia) that are suffering from low utilisation and could potentially see capacity rationalisations. This could in turn lead to more future provisions.

The Peterborough and Octagon projects are currently still status quo. This is one of the key risks for the company given that the Peterborough project accounts for around 50% of the outstanding order book (est. c.RM4.3b).

Forecast      Given that we expect further plant rationalisations, which could continue to impact KNM’s FY13-14 net profits. We are cutting our forecasted EBIT margins to 5.3% per annum (from 7.0-7.3% previously).

Overall, we cut our FY13-14 net profit estimates by 36.8% and 38.7% respectively.

Rating      CEASE COVERAGE

Valuation     The new earnings imply a CY13-14 fair value of RM0.33-0.38/share (reduced from our previous fair value of RM0.53/share based on an unchanged 9x target PER).

We note that the company continues to face significant operation challenges, which could likely continue to affect its earnings trend.

As such, we are ceasing coverage on the stock until we can see some clearer improvements in operations moving ahead.

Risks      1) Inability to secure more contracts going ahead; 2) the continued delay of its headline projects like Peterborough and Octagon; and 3) Higher-than-expected provisions.

Source: Kenanga