• D/G to NEUTRAL from Buy, with unchanged TP of MYR1.53, 6% upside. The upside to our TP has narrowed with Kelington’s share price by 10% over the past month. While earnings prospects remain positive going into FY23F- 24F, we think this has been sufficiently priced in by the market with the prevailing cautious outlook in the chip sector weighing on sentiment. Look to accumulate on share price weakness. Our TP factors in a zero ESG premium.

• Robust tenderbook still despite US export controls. Despite the tighter curbs imposed by the US on China’s semiconductor industry, KGRB said it has yet to see any signs of a slowdown, with a strong tenderbook of MYR1.7bn. Management contends that the export controls are primarily directed at advanced computing chips of 14nm and below, which are not the focus of the underlying expansion in China’s fab capacity. According to media reports, SMIC, China’s largest foundry, has built production lines that are free of US chipmaking equipment (non A-lines) with the emphasis on 28nm production over the next two years. KGB has to date (end-November) secured new orders of >MYR1.6bn, surpassing the FY21 record of MYR1.2bn. Management expects new tenders for fab capacity expansion to be called in 1H23 by Soitec, Micron and Siltronics in Singapore and that of SMIC, Huawei and other provincial governments in China.

• MYR1.6bn outstanding orderbook should keep the group busy well into FY24F. KGB expects to recognise c.MYR1.1-1.2bn of the outstanding orderbook in FY23F with the remainder booked in FY24F. Of the orderbook, c. 74% relates to the ultra-high purity (UHP) segment, followed by process general contracting (22%) and process engineering (4%). We expect the remainder of the turnkey MYR420m contract for the Sarawak hard drive maker to be booked in 1Q23 (parked under general contracting) with GPM expected to normalise to above 15% thereafter from 11.4% in 9M22.

• Phase 2 LCO2 plant to be ready by end-2023. Work has started on the new (70,000 tonnes) liquid carbon dioxide (LCO2) plant, which is adjacent to its current Phase 1 facility (50,000 tonnes) in Kerteh. When commissioned in FY24F, the new plant would more than double the revenue from the existing plant at full capacity. Our forecast has yet to factor in the new plant pending completion. Management sees further scope to expand the supply of LCO2 to new markets outside of Malaysia, with Indonesia being a key target. KGB currently supplies industrial gases to the Oceania markets which includes Australia, New Zealand, Papua New Guinea and Fiji.

• Key risks are weaker than expected earnings/margin and orderbook replenishment, and structural de-rating in the global technology sector.

Source: RHB Research - 23 Dec 2022