• Keep NEUTRAL, new DCF-derived MYR1.01 TP from MYR1.16 (WACC: 10.5%), 3% upside. We cut our earnings forecast to reflect the cautious outlook painted at the results call yesterday. Nevertheless, we expect core earnings to stage a strong 19% rebound in FY21F on an economic recovery, improved billings and stronger industrial gas business (IGB) contribution. Our TP implies 18x FY21F P/E (+1SD from its 1-year forward rolling 5-year mean), which we think is fair given the improvement in the stock’s risk profile.

• What’s next? Being the resident contractor for Semiconductor Manufacturing International Corp (SMIC), we expect Kelington to benefit from the aggressive capacity expansion of wafer fabrication in China. This comes on the back of US-China trade tensions, and the restriction imposed on Huawei to purchase from Taiwan Semiconductor Manufacturing Co (TSMC) and other US entities, potentially leading to more orders being diverted to SMIC. We gather that SMIC had earlier increased its capex guidance for FY20 by USD1.1bn to USD4.3bn (+34%) to cater for anticipated demand. Taken together, we think Kelington could potentially benefit from more ultra-high purity (UHP) contracts (specifically hook-up jobs) from SMIC. Outstanding works from SMIC are currently at MYR91m.

• Outstanding orderbook of MYR322m (April) which consists mainly of UHP jobs (72%). Despite that, we expect margins to narrow given the expectations that China would contribute a larger share of contract wins in the near term vs Malaysia and Singapore. Projects from China typically have lower yields due to stiffer competition. Nevertheless, we expect the contribution from the IGB to offset the potential impact.

• Utilisation rate of industrial gas plant at 18-20% in June, which is significantly lower than our expectations. We gather that the prices of LCO2 had fallen slightly due to weak demand, although still within guidance. We maintain our 37%/60% average take-up rate for FY20F-FY21F for now. The industrial gas business contributed MYR5m (+285% YoY, +22% QoQ) in 1QFY20, boosted by the new LCO2 plant which commenced in Oct 2019.

• FY20-FY21F core earnings cut by 14%, 4%, 3%, after factoring in a slower recovery in 2HFY20. We also updated our beta and equity risk premium to reflect our latest house assumptions. We think near-term earnings headwinds are priced in following the 22% decline in the share price YTD. We opine that the overall risk profile of the stock has improved, supported by the venture into IGB which offers more sustainable and recurring earnings in the longer term.

• Key downside risks include slower-than-expected orders, margin weakness, and execution. Upside risks include contract replenishment exceeding expectations, faster-than-expected recovery in demand for LCO2, and the pandemic subsiding.

Source: RHB Research - 5 June 2020