KEY INVESTMENT HIGHLIGHTS

• 3QFY20 normalised earnings improved by +152.9%qoq to RM11.0m, on prompt resumption of work operations
• Nonetheless, 9MFY20 normalised earnings slumped by - 20.8%yoy to RM22.2m as a result of lower progress billings
• Manufacturing sector continued to outperform, as 9MFY20 total revenue rose +73.8%yoy to RM115.8m
• Healthy order book of about RM840m which translates into earnings visibility for the next two years
• Maintain BUY with an revised target price at RM1.92

Recovery in quarterly earnings. KKB Engineering Berhad (KKB)’s 3QFY20 normalised earnings jumped by +152.9%qoq to RM11.0m, primarily driven by the resumption of its construction and business activities which led to higher progress claims. On a year-on-year basis, it slumped by -42.9%yoy on slower pace of work activities given the current Covid-19 standard operating procedures (SOPs) in place. Cumulatively, the group’s 9MFY20 normalised earnings decreased by - 20.8%yoy to RM22.2m as a result of lower revenue recognition from the group’s civil construction and steel fabrication divisions. However, this came in within our expectation accounting for 80.5% and 76.6% of our and consensus’ expectations. Moving forward, we expect KKB’s construction and business activities to continue to pick up pace.

Resilient operating profit margin. The group’s 9MFY20 revenue declined by -21.8%yoy to RM315.1m which was mainly as a result of lower revenue of RM50.0m (-34.8%yoy) from its construction division. 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. This, however, was partially offset by higher revenue of RM22.2m (+69.5%yoy) from the Steel Pipes manufacturing division in 3QFY20. The group also managed to contain its cost of sales in 9MFY20 to -RM252.4m (-25.5%yoy) which led to an improvement in operating profit margin of 12.4% (+2.5ppts yoy).

The manufacturing sector remains a bright spot. The group’s 9MFY20 total revenue for the manufacturing sector improved by +73.8%yoy to RM115.9m as predominantly driven by the strong revenue performance from the Steel Pipes manufacturing division (SPMD) which jumped +69.5%yoy to RM22.2m in the 3QFY20. This was mainly driven by the pent-up customer demand for Mild 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.

Dividend. There is no dividend declared for FY20 thus far. However, we are still maintaining our dividend forecast of 4 sen per share given the company’s strong balance sheet with a total cash balance of RM134.0m as of 30 Sept-20.

Earnings estimates. We are maintaining our earnings forecasts.

Target price. We are revising our TP to RM1.92 (previously RM2.18). This is derived through pegging a lower PER of 15x (previously 17x) to the group’s FY21 EPS of 12.8sen. The lower PER is to take into account the possible weaker business sentiments on the resurgence of Covid-19 cases in the country and lower-margin civil construction business sector to take lead into the coming years.

Maintain BUY. We posit that the group’s revenue and earnings prospects to remain healthy moving forward in anticipation of recovery in earnings following the resumption of construction and business activities. The group’s prospect is also well-supported by its healthy outstanding order book of about RM840.0m which will provide earnings visibility over the next two years. Meanwhile, we are of the view that KKB would 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. The expansionary Budget 2021 reaffirms our view on the potential upcoming developments in East Malaysia, whereby the group is poised to capitalise on new job replenishment opportunities given its strong track record in steel pipe manufacturing and local expertise in the civil construction in the region. This is premised on the sizeable combined allocation of about RM9.6b as development expenditure for the state of Sabah and Sarawak in year 2021. In addition, the Sarawak state government has announced an additional budget of RM9.8b for the state in the following year as well, focusing on projects such as the coastal road network (RM1.2b), Regional Corridor Development Authority (RECODA) projects (RM1.7b) and Integrated Regional Samarahan Development Agency (IRSDA) projects (RM792m). We postulate that these developments if materialise will bode well for the group’s order book replenishment rate in FY21, hence enhancing its earnings growth. Nonetheless, we do not discount the possibility of resurgence of Covid-19 cases at key operation sites to disrupt the group’s operational and financial performance. All factors considered, we maintain our BUY recommendation on KKB.

Source: MIDF Research - 17 Nov 2020