• NEUTRAL, new TP of MYR1.51 from MYR1.44, 4% upside with c. 3% FY23F yield. A recent meeting with management suggests the robust earnings momentum should have continued in 2Q23, buoyed by the group’s sizeable outstanding orderbook. The higher contributions from the ultra-high purity (UHP) and industrial gas segments should also see margins widen. We lift our earnings forecasts after factoring in higher margin assumptions. The stock’s risk-reward appears balanced with foundries deferring capacity investments amid the ongoing inventory adjustments in the tech space.

• We expect a good 2Q23, supported by a strong orderbook of MYR2.3bn (end-Apr 2023) which translates into 1.8x FY22 revenue and YTD (up to April) order wins of MYR568m (c.30% of FY22 new orders). 2Q23 revenue/core earnings could potentially see double-digit expansion YoY. As the UHP segment makes up a larger proportion of orderbook (1Q23: 66%; 1Q22: 64%), we see incrementally stronger gross margins.

• Phase two (P2) expansion of the liquid carbon dioxide (LCO2) plant on track for 3Q23 completion, with mainstream production to commence in 4Q23. The expansion should see an additional capacity of 70k tonnes (currently 50k tonnes), making Kelington a leading LCO2 producer in Malaysia. We see P2 utilisation hitting c.30% by year-end, with an annual increment of 20-30%. Growth should continue to be spurred by the bigger overseas footprint and the successful penetration into Oceania markets which rely on imported LCO2 to meet domestic requirements. We gather there has been a slight delay for the Kulim on-site gas project which will now commence in 1Q24 (previously 4Q23). The delay would have little impact as it is at the request of the client, with rental billings continuing.

• Cautious optimism in the fab industry. According to SEMI, wafer fab sales are anticipated to contract 18.6% to USD76.4bn in 2023, albeit with a 14.8% rebound in 2024. We remain cognisant of the headwinds impacting the chip sector which would continue to rub on the prospects of the wafer fab industry (some foundries have withheld their capacity expansion), a key customer segment for KGB.

• Forecasts raised slightly. We upped our FY24-25F core earnings by 1.9- 2.9% after tweaking our margin assumptions for the industrial gas segment. This is backed by heightened demand from the Oceania markets and our expectations of good incremental uplift in the utilisation for the P2 facility. Our TP is still premised on 18x FY24F P/E which is at +0.5 SD of historical mean. We adjust KGB’s ESG score to 3.1 (from 3.0) to reflect improving governance and greater transparency accorded on its business activities. It is worth noting that KGB was awarded ‘The 2022 Edge ESG Award’.

• Key risks include weaker-than-expected earnings and orderbook replenishment, delays in project execution, and de-rating in the tech sector. The converse would be the upside risks.

Source: RHB Research - 4 Aug 2023