9M18 CNP of RM38.2m came below our/consensus expectations, accounting for 65%/66% of estimates due to lower-than-expected margins from construction and manufacturing divisions. No dividends declared, as expected. Reduced FY18-19E CNP by 12-17%. Downgrade to MARKET PERFORM (from OP) with lower TP of RM1.15 (previously, RM1.40).

9M18 below expectations. 9M18 CNP of RM38.2m came below our/consensus expectations, accounting for 65%/66% of estimates. The negative deviation stemmed from lower-than-expected margins from construction and manufacturing divisions due to: (i) projects mix with higher composition of lower margins projects, (ii) higher supply mix of KVMRT2 SBGs which generally command lower margin, and (ii) sales of lower margin quarry products. We note that this is KIMLUN’s third consecutive quarter of disappointments. No dividends declared, as expected.

Results highlight. 9M18 CNP was down 14% YoY despite reasonable improvement in revenue (+14%), attributed to the compression in GP margin to 8% (-3ppt) weighed down by both its construction and manufacturing divisions. The GP margin compression in its construction division was due to higher recognition of projects with lower margins, while GP margin for its manufacturing was dragged down due to: (i) higher sales mix of KVMRT2’s Segmental Box Girders (SBG) that commands lower margin compared to Tunnel Lining Segment (TLS), and (ii) higher sales of lower margin quarry products. Meanwhile, QoQ, 3Q18 CNP picked up 60%, outpacing an increase of 20% in revenue. The positive deviation was attributed to: (i) higher revenue contribution from manufacturing division, which is a more profitable division, and (ii) improvement in GP margin for manufacturing division.

Outlook. Based on announcements to Bursa, we gathered that YTD, KIMLUN has secured RM440m of contracts (Construction: RM360m; manufacturing RM80m) accounting for 77% of our replenishment target of RM570m (Construction target: RM450m; Manufacturing target: RM120m), which we believe is achievable as there could be some smaller job wins that are not required to be announced by the company. Moving forward, we believe competition will intensify as local contractors compete for a shrinking pie which should see some margin compression. On a positive note, currently, KIMLUN’s outstanding order-book stands at c.RM2.3b (construction RM1.9b; manufacturing RM0.4b) providing 2-year visibility, which should help them weather through these uncertain times.

Earnings estimates. Post results, we reduce FY18-19E earnings by 12-17% after we tweaked average margins for both construction and manufacturing division to 13% (-2ppt).

Downgrade to MARKET PERFORM (from OP), with a lowered TP of RM1.15, (previously RM1.40) based on an unchanged valuation of 7.0x FY19E PER which is at the lower end of the 6-11x range which we ascribed to small-mid cap players. We pegged KIMLUN to the lower end of our valuation range in line with the smaller contractors and due to their projects mix with lower margins. We believe our downgrade is justifiable given KIMLUN’s three consecutive quarters of earnings disappointment and compression in margins.

Key risks for our call are: (i) higher/lower-than-expected margins, and (ii) acceleration/delay in construction works.

Source: Kenanga Research - 30 Nov 2018