Kelington Group - Poised for Better Margins and More Jobs

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KGB guided for its boosted margins to sustain in the coming quarters given the delivery of high-margin ultra-high purity (UHP) gas systems. It is poised to bag a few more jobs to end the year with RM1b job wins (vs. YTD RM858m). Its LCO2 Plant 2 is coming online by end-CY23, just in time to capitalise on the current LCO2 shortages in the market. We maintain our forecasts, TP of RM3.28 and OUTPERFORM call.

We came away from KGB’s post-3QFY23 briefing thrilled about its near-term prospects. The key takeaways from the meeting are as follow:

1. The margin recovery in the reported 3QFY23 was on the back of favourable revenue mix as the group refocused its resources on higher margin UHP gas systems after completing the turnkey job for an MNC that produces memory chips. With UHP making up 68% (vs. 59% in the recent 3QFY23) of its RM1.5b outstanding orderbook, the group anticipates improving margins and hence profitability in coming quarters.

2. Despite SEMI’s estimate of an 18% decline in fab equipment spending in 2023, KGB has successfully replenished RM858m net orders YTD. With several high-potential orders in final stages, including a significant hook-up job in China’s largest foundry, the company is poised to achieve our RM1b replenishment target. Upon securing this, it will add on to the existing five foundries from the same customer that KGB has secured renewals until the end of 2024, solidifying its position as the leader in the region.

3. Its LCO2 (liquid CO2) Plant 2, with capacity of 70k tonnes/year or 1.4x of Plant 1, has been completed and will begin testing and commissioning next week. This means the group could start exporting from Plant 2 as early as end-2023. This will alleviate the bottleneck at Plant 1 (running near 100%) as demand continues to increase with a worsening shortage of LCO2 in Asia and the Oceania region.

4. Our conviction in KGB's prospects is well-founded, supported by its impressive >RM2.1b tender book and its commanding presence in the regions it serves. The robust tender pipeline is in line with SEMI's forecast of a 12% recovery in 2024, followed by a substantial 24% upcycle in 2025. Be it a smooth or bumpy recovery for the semiconductor sector, the group still has RM1.5b outstanding orders in its bag to navigate any obstacles that may come along, thereby fortifying its readiness for the next wave.

Forecasts. Maintained.

We keep our TP of RM3.28 based on an unchanged 21x FY24F PER. Our valuation represents a c.10% discount to peer’s forward mean PER of 24x which includes global players such as Air Products, Air Liquide and Linde. There is no adjustment to our TP based on ESG given a 3-star rating as appraised by us (see Page 4).

Investment thesis. We like KGB for: (i) it being a direct proxy to the frontend wafer fab expansion, (ii) its strong earnings visibility underpinned by robust order book and tender book exceeding RM1b, and (iii) its strong foothold in multiple markets, i.e. Malaysia, Singapore and China. Maintain OUTPERFORM.

Risks to our call include: (i) chip makers halting their expansion plans due to oversupply, (ii) worsening Sino-US chip war, and (iii) delays in its LCO2 plant expansion.

Source: Kenanga Research - 30 Nov 2023

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