1Q18 CNP came below expectations due to lower-than expected contributions and margins from KIMLUN’s manufacturing arm. Coupled with the unexpected change in government, which caused delay/termination in mega infrastructure projects, we reduce our FY18-19E earnings by 14-20% after accounting for lower construction and manufacturing replenishments. Downgrade to MP with lowered TP of RM1.80.

Below expectations. 1Q18 CNP of RM14.0m came below our/consensus expectations, accounting for 17%/18% of estimates due to lower-than-expected contributions and margins from KIMLUN’s manufacturing division as delivery of their KVMRT2 SBGs was deferred due to stoppage of construction works involving the launch of gantries after an unfortunate accident in March-18. No dividend was declared, as expected.

Results highlight. 1Q18 CNP was down 45% QoQ mainly due to lower revenue recognition (-41%) from lower construction billings (- 43%) as there were a couple of project completions/account finalizations in 4Q17 and higher effective tax rate (+7ppt) as there were non-tax deductible expenses recorded in 1Q18. 1Q18 CNP was down marginally by 1% YoY despite the higher revenue (+30%) due to: (i) lower margins from its manufacturing division (-27ppt) stemming from higher staff costs and lower margins sales mix i.e. more quarry products vs precast products, and (ii) higher group depreciation (+69%) and finance costs (+54%).

Dampened outlook. With the new PH government reviewing and terminating major infra projects, we view this as less favourable for KIMLUN as they were gunning to participate in these mega rail projects, i.e. MRT3 (terminated), HSR (terminated) and ECRL (review) either in the construction packages or precast supply packages. We also foresee more contractors competing within a shrinking pie given the lack of major infra jobs. In view of this, we reduce our (i) FY18/19E construction replenishment target for KIMLUN to RM700m (from RM1.0b), and (ii) FY18/19E manufacturing replenishment target for KIMLUN to RM120m/150m (from RM300m). YTD, KIMLUN has secured RM40m worth of construction jobs and current outstanding order-book (as of 31/3/18) stood at RM1.94b (construction RM1.58b; manufacturing RM0.36b) providing 2-year visibility.

Earnings estimates. Post results, we downgrade FY18/19E earnings by 14/20% after accounting for: (i) lower progress and margins for their manufacturing division, (ii) lower FY18/19E construction replenishment of RM700m (from RM1.0b), and (iii) lower FY18/19E manufacturing replenishment of RM120/150m (from RM300m).

Downgrade to MARKET PERFORM (from OP) with a lowered TP of RM1.80 (from RM2.55) after rolling forward valuation base year to FY19E on reduced target PER to 8.0x (from 10x). Our de-rating in valuations is a broad-based downgrade given the uncertainties arising from a new government. We believe our downgrade in rating is justifiable given the weaker outlook ahead from slower job flows coupled with more intense competition for construction jobs, which could spell weaker margins.

Key downside risks for our call are: (i) lower-than-expected margins, and (ii) delays in construction works.

Source: Kenanga Research - 31 May 2018