FY15 results were within expectations. Recall that we issued a report on process equipment manufacturer KNM Group Bhd (KNM) in December last year; the company recorded core net profit of RM82.3m (23.1% growth YoY) in FY15, in line with our estimates, after stripping off: (i) deferred tax charge of RM55.8m, and (ii) gain on disposal of subsidiaries amounting to RM19.9m. We opine that the earnings performance was largely attributable to favourable currency movement given that KNM’s EBITDA fell 2.3% to RM263.1m last year. Weaker EBITDA was dragged by Europe segment where jobs were mostly at either completion or beginning stage that resulted in lower earnings recognition.

First Peterborough financing sealed. We gathered that KNM recently secured EUR30m financing for the Peterborough project at an attractive rate of 1.45% + EURIBOR vs. 6-7% rate available in Malaysia. The company is in the midst of taking a second financing through a GBP35m local loan at a higher interest rate of c.6%. The construction of this wasteto- energy plant is likely to go full force in 2H16 and to be completed by 3Q17. Management is looking to generate full-year PATAMI of RM40m from the first-phase capacity of 17.6MW and up to RM160m upon full capacity of 80MW which could take up to 7 years to complete.

Its 72%-owned Thailand bioethanol project is on track for commercialisation by 2Q16. Once a firm commissioning date is secured, KNM would firm up the contracts with off-takers while ensuring no single client contributes lumpily to the bottomline. Assuming 85% utilisation on the 200,000 litres/day cassava-based bioethanol plant, it would generate approximately RM15m for 12 months of operations. Should this project successfully take off, it would mark the maiden step for KNM to establish its recurring income business model.

More RAPID jobs coming in 2H16? To recap, KNM was on a contract winning streak securing more than RM1.2b worth of EPC and process equipment supply projects in 2H15. We believe earnings will pick up this year as these projects enter the fabrication and construction stage. While we are expecting more RAPID-related jobs to be dished out, YTD, KNM has only managed to bag a RM57.8m sub-contract relating to civil and underground piping work from Sinopec through its 50%-owned jointventure company with HOHUP. We believe most contract awards from RAPID could happen in 2H16 and will lend support to FY17 earnings.

Total outstanding orderbook currently at RM2.8b spanning the next three years. Management still aims to secure RM500m worth of contracts replenishment each quarter. While we anticipate the RAPID project to experience a slight slowdown, overseas projects such as Al Zour Refinery are keeping the management excited. This USD16b mega project, led by Kuwait National Petroleum Co is set to raise Kuwait’s processing capacity by 615k bbls/day. KNM has bagged its first USD25m project beginning of the year and expecting more to come.

Trading Buy call with Fair Value of RM0.57 pegged to 11x CY17 PER, which is higher than our average PER of 8-9x ascribed to O&G small-mid caps due to: (i) its exposure in the downstream segment which is less affected by oil prices, and (ii) its recurring income business model prospect but still 55% lower to DIALOG’s valuation. Note that our FV assumes no conversion of shares from out-of-money warrants and we have yet to factor in earnings contribution from Peterborough, which could serve as a re-rating catalyst to the stock. Risks to our call are: (i) unexpected margin compression on core business, (ii) delay in Thailand ethanol project, and (iii) inability to generate recurring income from Peterborough plant.

Source: Kenanga Research - 12 Apr 2016