· Boosted by exports. Driven by stronger export sales, 9M14 revenue rose 40% to RM47.1m. However, profit before taxation fell 18.9% to RM6.3m due mainly to lower gross profit margin of 17.4% in Q3 2014 as compared to 26.0% in Q3 2013, as well as an increase in administrative expenses following additional compliance expenses attributable to its listing status. The decrease in gross profit margin was due mainly to an increase in sales of horizontal and vertical bamboo flooring products, which generally command lower gross profit margin as part of its effort to clear older stocks.

· Making cash-call. To recap, the Group has proposed to undertake a fund raising programme by issuing redeemable convertible notes up to RM100m in early January this year. The proceeds will be utilised for the acquisition of bamboo plantation land (30%), capex and working capital (27.4%), property investment (22.5%), and expansion of dealerships (13.5%). While we view the substantial fund as supportive of the expansion and growth plan, we are wary of the earnings downside considering: (i) potential dilution upon conversion of the notes into shares, which could enlarge its share base by as much as 60%, and (ii) interest cost of RM2m per annum (c.40% of 9M14 net profit amounting to RM5.1m).

· Reducing reliance to core business. In the same announcement, the Group also proposed its plan to diversify into property investment and management. The development will see KANGER leasing a commercial building to be built by the Group to Ganzhou Detong Technology Development Co., Ltd (GDTD). We understand that the building will be run as a hotel as the lessee, GDTD is a licensee of Vienna Hotel. Financially, the contract is estimated to generate RM3.2m of gross rental income per annum once the building is completed two years after getting the approval from the authorities while the building costs is projected at RM22.5m. Thus, earnings will only kick in earliest by end of 2017.

· Robust growth projected. Growth potential moving forward will be underpinned by increasingly affluent consumers as well as the modernisation and urbanisation of China’s property market, an industry the bamboo flooring market is dependent on, all thanks to China’s strong economic growth. Based on Protégé Associate Sdn Bhd, an independent market research report, the bamboo flooring market in China is expected to grow at a compound annual growth rate (CAGR) of 8.4% for the year 2012 to 2017 to RMB5.04b in 2017.

· Not Rated. Last closing price of RM0.41 implies 22.8x FY15E EPS, a premium that appears to be lofty (vs. FBMSC Fwd. PER of 9.9x & China-based companies’ average historical PER of 3.3x) even after considering its exciting earnings growth as the Group is projected to clock 37.6% and 23% of net profit growths in FY15 and FY16, respectively.

· Key risk: a.) stronger-than-expected competition in China, b.) Unfavorable forex as the sales are denominated in Yuan, 3.) high valuation premium as compared to other China companies listed in Malaysia averaging 3.3x. 

Source: Kenanga