KGB is well-positioned for growth, buoyed by high-margin UHP projects making up the majority of its RM1.45b order book, and a rising tender book supported by a strategic partnership for the market in Germany. In industrial gases, strong liquid CO₂ demand drives growth, with capacity expansion planned as utilisation nears 90% within 3-4 years. The addition of an industrial gas subsidiary and potential carbon capture partnerships enhance further growth potential. Hence, we have raised our FY24 and FY25 net profit forecasts by 8% and 15%, respectively, but maintain our TP at RM4.16, based on a 21x FY25 PER on an enlarged share capital, assuming a progressive 25m warrant conversion per quarter.

We came away from KGB's post-3QFY24 briefing reassured of its promising outlook. The key takeaways from the meeting are as follow:

1. 3QFY24 results insights. KGB reported an unrealised forex loss of RM6.9m in 3QFY24, which could potentially be reversed in 4Q if the MYR/USD exchange rate normalised around RM4.40/USD. The group achieved a strong GP margin of 22.8% in 3QFY24, mainly driven by high-margin Ultra High Purity (UHP) gas solution projects, a trend expected to continue with a solid pipeline of UHP projects.
2. Strategic focus on UHP projects. KGB has sharpened its focus on UHP gas solution projects, now representing 78% of its RM1.45b outstanding order book as of 9MFY24, up from 74% of RM1.3b in FY23. Its tender book has also expanded to RM2.62b, a notable increase from RM1.67b in 2Q, driven mainly by a strategic partnership with a leading Taiwanese semiconductor company to target UHP projects in Germany, leading us to revise our margin and order book assumptions. Management is optimistic about securing contracts from this new market in 1HFY25, supported by its strong track record and a strong partner. The group has secured RM1b in new job wins as of end 3QFY24. We are targeting KGB to secure RM1.2b in FY24 and RM1.6b in FY25.
3. Rising demand in Industrial Gas segment. KGB's industrial gas segment achieved solid growth, with turnover reaching RM113m (+26% YoY, with 71% from exports) in 9MFY24, fuelled by increased liquid carbon dioxide (LCO₂) sales amid regional shortages from decarbonisation-linked plant shutdowns. Operating at a 60% utilisation rate on its 120,000 MT annual capacity, KGB has secured adjacent land near its two LCO₂ plants and plans to expand capacity once utilisation reaches 90%, projected within 3-4 years. Additionally, KGB is going to complete the acquisition of the remaining 9% stake in its 91%-owned industrial gas subsidiary by 19 November 2024, expected to enhance group contributions. KGB also shared it has discontinued discussions on acquiring an Indonesian LCO2 business due to unmet conditions from the seller.
4. Exploring Carbon Capture opportunities. KGB is exploring local carbon capture initiatives via leveraging its experience with the Kerteh liquid carbon dioxide (LCO₂) plant. The Kerteh facility which captures CO₂ emissions and converts them into food-grade LCO₂, serves as a proven model for such projects. While specific details are currently limited, KGB anticipates announcing collaborations or partnerships in this area in the coming months.

Forecasts. We raised our FY24F/FY25F net profit by 8%/15%, respectively, driven by higher GP margin assumptions of 19% (vs. 16.5% previously) and increase FY25 new orders expectations by RM300m to RM1.6b.

Valuations. We have factored the 174m outstanding convertible warrants (expires on 24 July 2026 with an exercise price of RM1.38) progressively into our share base calculations, expecting investors to convert the warrants to benefit from KGB's long-term growth prospects rather than short-term trading. The enlarged share based resulted in our TP being maintained at RM4.16 based on an unchanged 21x FY25 PER. Our valuation represents a 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 case. We like KGB for: (i) being a direct proxy to the front-end 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) a slowdown in wafer fab investment, (ii) worsening Sino-US chip war, and (iii) low utilisation of its LCO2 plants.

Source: Kenanga Research - 14 Nov 2024