• BUY, new MYR1.60 TP from MYR1.85, 22% upside, c.4% FY23F yield. KKB Engineering’s 9M22 core profit of MYR4.8m missed expectations, at only 27% and 22% of our and Street’s estimates. The negative deviation was mainly due to higher cost of sales arising from the volatility of raw material prices. Nevertheless, we believe raw material prices, such as for steel bars, may continue to ease in the coming quarters. The stock is trading at an undemanding 14x FY23F P/E, at -1SD below the 5-year mean.

• Results review. 3Q22 core earnings of MYR1m (-36% QoQ, -89% YoY) were partly dragged by losses before tax of MYR40k (3Q21 PBT: MYR839k) in the manufacturing segment, due to the absence of new major contracts for the supply of steel pipes under the Sarawak Water Supply Grid Programme (SWP). The engineering segment saw 4% YoY revenue growth amid higher progress billings, backed by the Pan Borneo Highway (PBH) project (>70% completion), and progress from steel fabrication works for the Bakau, Jerun and Kasawari projects, among others. The engineering segment’s PBT margin contracted to 5% in 3Q22 (3Q21:14%) amid higher input costs.

• Outlook. KKB submitted bids for MYR203m worth of projects in 2Q22, of which MYR123m is for oil & gas (O&G) platform fabrication jobs. Outcomes should be known at end FY22, and we believe the total amount of bids has exceeded MYR203m since 2Q22. We reiterate that higher Petronas capex should boost OceanMight’s steel fabrication business for O&G platforms, with it being the only other Petronas-licensed fabricator in Sarawak besides Brooke Dockyard and Engineering Works Corp. As such, we maintain our MYR150m FY22F job replenishment assumption despite KKB only winning c.MYR71m worth of contracts so far this year. Petronas plans to increase the contract threshold for Sarawak companies from MYR10m to MYR50m for the upstream sector, potentially benefitting KKB indirectly.

• Earnings and valuation. We slash FY22-24F earnings by -54%, -14%, and -8% after imputing more conservative input cost assumptions and toning down margin projections. As such, we arrived at our MYR1.60 TP pegged to unchanged 17x target FY23F P/E, with 0% ESG premium/discount based on our in-house methodology. While the target P/E is +1SD and >+2SD from the 3-year historical mean of its own P/E and the KL Construction Index’s, we believe this is justified given the multiple catalysts on the horizon, backed by Sarawak's c.MYR100bn injection into its economy by 2030, which may support the pipeline of future projects. Valuation target is in line with KL Energy Index’s 17x 3-year mean P/E, which reflects O&G activity, leading to potentially better prospects for fabrication services for O&G platforms, underpinned by higher Petronas capex.

• Key risks. Failure to secure new contracts, higher-than-estimated cost of raw materials, and a slowdown in construction activities.

Source: RHB Research - 17 Nov 2022