KEY INVESTMENT HIGHLIGHTS

• 2QFY20 normalised earnings fell to RM4.4m (-19.4%yoy)
• Nonetheless, 1HFY20 normalised earnings increased by +27.2%yoy to RM10.8m as a result of margin improvement
• Manufacturing sector continued to outperform, as 1HFY20 revenue rose +115.9%yoy to RM69.8m
• Healthy order book of about RM800m which translates into earnings visibility for the next two years
• Maintain BUY with an revised target price at RM2.18

Foresee pick up in activities in 2HFY20. KKB Engineering Berhad (KKB)’s 2QFY20 normalised earnings fell by -19.4%yoy to RM4.4m, primarily due to the disruption brought on by the movement control order (MCO) on construction and business activities which led to lower progress claims. Cumulatively, the group’s 1HFY20 normalised earnings increased by +27.2%yoy to RM10.8m, mainly driven by improved profit after tax (PAT) margin at its manufacturing division. Despite 1HFY20 earnings performance only made up 37.4% of ours FY20 earnings estimates, we expect KKB’s construction and business activities to pick up pace in 2HFY20.

Shift in revenue composition. The group’s 1HFY20 revenue declined by -16.9%yoy to RM197.4m which was mainly as a result of lower revenue of RM32.8m (-53.6%yoy) from its construction division. This, however, was partially offset by higher revenue of RM12.7m (+429.2%yoy) from the Steel Pipes manufacturing division in 2QFY20. The decline in revenue from the construction division was due to lower progress claims from the Pan Borneo Highway project (WPC-09) during the MCO period. Nonetheless, the group managed to contain its cost of sales in 1HFY20 to -RM159.2m (-22.0%yoy) which led to an improvement in operating profit margin of 11.1% (+3.9ppts yoy).

The manufacturing sector outperformed. The group’s 1HFY20 total revenue for the manufacturing sector improved by +115.9%yoy to RM69.8m as predominantly driven by the strong revenue performance from the Steel Pipes manufacturing division (SPMD) which jumped +429.2%yoy to RM12.7m in the 2QFY20. This was mainly boosted by the increase off takes of Steel Pipes required under the Sarawak Water Supply Grid Programme. We opine that this division would continue to benefit from the increased allocation for the Sarawak Water Grid programme as evidenced by the group’s new water supply job win from Kuching Water Board (KWB) in May-20. Thus, we are of the view the continuous upgrading of water supply systems in Sarawak will provide a synergistic benefit to the group’s SPMD and Steel Fabrication division within its Engineering Sector as well moving forward.

Earnings estimates. We are making some housekeeping changes to our earnings estimates to also take into account the impact of the MCO on the group’s businesses. We revise our FY20 and FY21 earnings forecast to RM27.6m and RM33.1m from RM29.0m and RM36.1m respectively.

Target price. We are revising upwards our TP to RM2.18 (from RM2.10). This is achieved through pegging a PER of 17x (from 15x) to the group’s FY21 EPS of 12.8sen. Note that the PER is the group’s one year historical average and we are attaching a higher PER due to the group’s shift of better business mix and improving operating margin.

Maintain BUY. We posit that the group’s revenue and earnings prospects remain healthy moving forward in anticipation of recovery in 2HFY20 earnings following the resumption of construction and business activities and increased workforce capacity at work sites as seen during the Recovery MCO period. The group’s prospect is also well-supported by its healthy outstanding order book of about RM800.0m which will provide earnings visibility over the next two years. Meanwhile, we are of the view that KKB could continue to be a beneficiary from the potential mega infra projects roll-out in the state of Sarawak and Sabah (i.e. Sarawak-Sabah Link Road, Trans-Borneo Highway project, Sarawak Water Supply Master Plan and Water Grid, Sarawak Petrochemical Hub) in the foreseeable term. All factors considered, we maintain our BUY recommendation on KKB.

Source: MIDF Research - 14 Aug 2020