This article first appeared in The Edge Financial Daily on August 27, 2018

KUALA LUMPUR: Integrated engineering solution provider Kelington Group Bhd, which expects to secure two more ultra high purity (UHP) projects by the end of this year, is training its eyes on opportunities in the UHP space that will emerge for the group as tensions between the two biggest economies in the world heighten.

It is optimistic about securing more UHP projects from China, where capital spending is at a record high as the country continues to ramp up production capacity of memory chips and integrated circuits, in conjunction with its “Made in China 2025” policy.

UHP systems are Kelington’s largest revenue contributor, making up 73% of its top line for the first quarter ended March 31, 2018 (1QFY18), up from 42% in 1QFY17, which Kelington chairman and chief executive officer Raymond Gan said is due to China’s semiconductor expansion.

The group, which in January this year forecast a net profit growth of up to 30% for FY18, is also keeping to its double-digit earnings growth projection. It remains bullish about its growth, with China as its “main growth engine”, said Gan in a recent interview with The Edge Financial Daily. In 1QFY18, Kelington’s revenue contribution from China almost quadrupled year-on-year (y-o-y) to RM46.7 million from RM11.8 million. China’s contribution alone made up 54% of the group’s total revenue during the quarter.

Under the UHP system segment, the group serves industries that require UHP gases and chemicals in specialised applications, such as semiconductor manufacturing, which is the “core” industry the group serves. Though the US-China trade war is seen as a key risk to the semiconductor industry, Gan is unfazed. He believes the industry as well as the group’s semiconductor business will continue to grow for the next three to five years.

“We have seen that the number of projects that have been put out for tendering increasing a lot. So we definitely can see that the momentum is growing,” said Gan, adding that this has enabled Kelington to be more selective in identifying its clients. “Our UHP [segment] is more focused on the higher end of the value chain, such as chip manufacturing, and wafer fabrication, which China still lacks.”

The two new UHP projects it expects to secure will come from China and Singapore, said Gan. As at July 15, Kelington had secured new contracts worth RM236 million year to date, bringing its outstanding order book to RM341 million. It has bid for another RM1 billion worth of jobs.

Of the RM341 million outstanding order book, UHP projects top the list with 56% of orders, followed by process engineering (29%), general contracting (14%) and the industrial gas business (1%). For the industrial gas business, Gan said Kelington is also eyeing to secure two more projects, though he was close-mouthed about the details.

Up to 90% of the group’s order book will be fully recognised this year, said Gan, which means it will see at least RM272.8 million worth of sales recognised this year. The group is targeting to achieve a net profit margin of about 5% for FY18. Its net profit margin climbed from 2.6% in FY16 to 3.8% in FY17 and reached 4.9% in 1QFY18.

“We [want to] try to sustain a steady growth. Since last year, we have started to fine-tune and increase our efficiency by getting meaningful projects, and running projects more profitably,” said Gan.

“We do not aim to immediately double or triple our revenue as we want to have steady growth,” he said, adding that the group wants to grow its gross profit margin level more so than revenue.

In 1QFY18, Kelington’s net profit more than doubled y-o-y to RM4.21 million from RM2.07 million, as revenue grew 53% to RM86.55 million from RM56.5 million. Kelington’s full-year net profit for FY17 jumped 38% y-o-y to RM12.26 million from RM8.87 million, despite revenue slipping 8% to RM317.42 million from RM343.34 million.

While UHP was the star performer in 1QFY18 in terms of revenue, the remainder consisted of process engineering (17%), general contracting (9%) and industrial gases (1%). Though the contribution from the last — industrial gases — looks dismal at this juncture, the group expects it to become a core contributor in the next five years.

This is because Kelington will be attaining a new recurring revenue stream under its industrial gas business, Gan said, and the group will continue to invest in it.

He was referring to the agreement it secured from Petroliam Nasional Bhd (Petronas) last November, under which it will purify and liquefy carbon dioxide waste gas for Petronas into liquid carbon dioxide (CO2) at a new plant it is building, to be sold to end users. The agreement is for 15 years, starting from 2019.

“We think we will see the full-earnings impact in five years, but the impact will only be seen on the third-year operations ... when the CO2 plant starts production. We will only start seeing meaningful revenue from 2020, as the plant will only be ready in 3QFY19,” said Gan.

Gan added that the industrial gas business is a high-profit-margin business, with the gross-profit margin averaging about 30% to 40%. Kelington also sees expansion opportunities in Singapore, Indonesia and the Philippines for its industrial gas, which is in tandem with growing demand for industrial gases in the region.

In just two years, Kelington’s share price has jumped 188% from 30 sen to close at 86.5 sen last Friday. This brings its market capitalisation to RM218.64 million. But Gan thinks Kelington’s share price is still “undervalued”.

Since initiating coverage of the stock at 66 sen, Rakuten Trade Sdn Bhd vice president Vincent Lau said the research house remains positive about Kelington’s prospects. “Kelington’s 1QFY18 results were strong and we expect the upcoming 2QFY18 results to remain strong,” said Lau. Rakuten forecasts Kelington’s net profit to reach RM20 million in FY19.

Kelington, with its UHP core business, also has no direct peer in the Asean region, according to Lau. The closest is China’s PNC Process Systems Co Ltd, which has a trailing 12-month price-earnings ratio of 108 times. In comparison, Kelington’s 15 times looks much cheaper.