INVESTMENT MERIT

We close position on KTC with a “Not Rated” call with a FV of RM0.275 at a 14.0x FY18E PER. While stock prices have sustained above its IPO price, earnings have been under pressure, probably from heavier operating costs and loss of economies of scale from its expansion in Sarawak and Brunei. Though we believe margins could be normalising in the near term, current valuations suggest that the prospects for recovery may have already been priced in.

Fell short but getting back on its feet. After its listing on Nov 2015, the group reported a decline in FY16 earnings at RM1.9m, -74% YoY from RM7.1m in FY15. Despite the rise in revenue to RM341.1m (+14%), the poorer results can be attributed to weaker operating margins from higher marketing expenses incurred towards securing a larger portfolio of goods and writing-off of obsolete inventories. In the group’s latest 9M17, revenue grew by 28% YoY to RM311.7m thanks to greater contribution from activities in Sarawak, which led 9M17 net earnings to expand by 98% to RM1.9m.

Spreading roots into broader markets. As the group predominantly operates in Sabah, a large proportion of the Sarawak and Brunei market remains untapped. In Jan 2016, the group acquired Popular Trading (Borneo) Corporation Sdn Bhd to leverage on its existing presence and network in Sarawak’s distributorship scene. Further, as part of its IPO proceeds, the group has utilised RM3.0m of an allocated RM9.0m to acquire 100% of Trans Paint Sdn Bhd to expand its Sarawak warehousing facilities and 60% of Grandtop Marketing Sdn Bhd, which has a sizeable sales and distributing network in Brunei, further enlarging the group’s outreach.

Any saving grace from shrinking earnings? We reckon the eroding earnings despite strong sales growth is caused by the group’s gestation phase from its newly acquired Sarawak operations. Furthermore, as more distribution rights are being secured, further synergy of its distribution networks needs to be accomplished, especially on the group’s Sarawak and Brunei footprints, in order to achieve the economies of scale as with the group’s core Sabah operations prior to its aggressive expansion. Presently, the group possesses the rights to distribute Proctor & Gamble products, alongside the Anakku diapers and Marigold milk brands. Given time, we believe margins could normalise in the near term as the larger group operations become more streamlined. We estimated FY17E to close with RM417.7m sales (+22% YoY) with an EBITDA of RM16.2m (+61% YoY) arising from the recovery in margins (3.9%, +1.0 pts YoY) as a result of better operational efficiency, for a FY17E NP of RM2.9m (+54% YoY). Towards FY18E, we believe sales could potentially grow at 13% to RM472.0m from larger contributions from Sarawak. EBITDA margins could also record at 4.4% for RM20.6m (+27%) EBITDA and potential net earnings of RM6.2m (+>100%).

Not Rated with a FV of RM0.275. Our TP is derived from an ascribed 14.0x targeted PER, which is in-line with the 2-year average trading PER of the group’s selected distribution peers, on the group’s FY18E EPS. While this is a premium from our previously ascribed 11.0x PER (previous call, Trading Buy @ RM0.24), we believe it is not excessive as the potential normalising of margins backed by exponentially larger sales could lead to stronger earnings. However, at the current price performance, it is likely that the abovementioned positives have been priced-in and hence, we close position on this stock. Further, dividend prospect appears slim in the near term.

Source: Kenanga Research - 6 Jun 2017