Moving up the value chain

Cheapest infrastructure stock to buy. Within our construction universe, Kimlun Corp (Kimlun) stands out as the most direct small cap proxy to the sector which also boasts an under- appreciated manufacturing division. Despite the strong earnings delivery with stronger order replenishment ahead, Kimlun is currently trading at a bargain valuation of 7x FY17F EPS.

Record orderbook to underpin earnings growth. We estimate its construction orderbook stands at RM1.9bn where the largest project is the Pan Borneo Highway (PBH) Sarawak project. Its total orderbook including manufacturing is RM2.3bn. In spite of its exposure to the weak Johor property market, it has managed to deliver strong earnings. We believe its exposure to Johor will be partially offset by more infrastructure-related works. Moreover, clinching the PBH contract worth RM1.46bn further validates this. Some of the strategies for its construction division are to target non-residential projects, bid for more infrastructure-related projects and look for opportunities outside of Iskandar Malaysia. This is already taking place and is reflected in the strong margins for construction.

Under-appreciated manufacturing division. The key differentiating factor for Kimlun vs other contractors is its precast division which boasts gross profit margins of >20%, aided by less intense competition. The award of the RM199m Segmental Box Girder (SBG) project and RM53m for Tunnel Lining Segment (TLS) for MRT Line 2 has further bolstered the earnings prospects of this division. In addition, this division will benefit from more MRT projects in Singapore, as well as higher adoption of IBS related works.

Valuation

Our TP is set at RM2.87, based on 10x FY17F PE. At 10x, this is the mid-point between its mean and +1SD valuation, which we think is fair given its still strong orderbook, impeccable earnings delivery and strong balance sheet.

Key Risks to Our View

Low-margin wins. The biggest risk is its perceived overreliance on projects in Johor. We think this is mitigated by its stringent bidding process where it only accepts projects from strong clients while also ascertaining the saleability of the project.

Source: Alliance Research - 19 Jan 2017