This article first appeared in The Edge Malaysia Weekly on October 28, 2019 - November 3, 2019

AFTER suffering a dramatic decline in its fortunes over the past decade, KNM Group Bhd appears to be back on the radar screen of investors, with its share price climbing more than 500% so far this year.

The improvement in the bottom line of the group — which is involved in providing construction, manufacturing and engineering services for the renewable energy, power, utilities, refining and petrochemical industries — started early this year. It reported a net profit of RM21.12 million for the first half of its financial year ending Dec 31, 2019. Its share price has been rallying in tandem, pushing KNM’s market value to more than RM1 billion on July 16.

The last time it was valued at more than RM1 billion was May 5, 2016.

How did it get to this point? More importantly, what are its prospects and can it realise the value of the jewel in its crown, Borsig GmbH? Is the recovery sustainable, and will KNM be able to give good returns to its shareholders?

“We have undergone a transformation over the last few years due to the downturn in the oil and gas market. Since 2014, we have disposed of our subsidiaries in Brazil, South Africa and Indonesia and scaled down our operations in China and Canada,” founder and group CEO Lee Swee Eng tells The Edge in a recent interview.

“All these subsidiaries were not doing well because of the downturn. So, we have right-sized our operations in Asia in accordance with the market and new contract flow. By doing so, you can see in the first half this year, the bottom line has improved.”

In 1HFY2019, KNM reported a net profit of RM21 million compared with a RM53 million net loss in the previous corresponding period. The turnaround was due to better cost control and higher-margin contracts as revenue only grew by a marginal 3% year on year.

Meanwhile, KNM has secured almost RM650 million worth of contracts since November last year, most of them in Asia.

Expanding too quickly

Listed in 2003, KNM quickly ramped up its operations through acquisitions of technology companies in Italy and Brazil, and bought out its partner in Australia. These acquisitions allowed it to take part in projects in Europe and South America, and to consolidate its Australian presence.

In 2008, KNM acquired Borsig, a German process equipment manufacturer, for RM1.7 billion. At that time, KNM was already a stock market darling. Its share price hit RM7.62 apiece on Jan 8, 2008.

Borsig gave KNM a strong presence in Europe and the Middle East, complementing its homegrown subsidiary, KNM Processing System Sdn Bhd, which caters mostly for demand from Asia and Oceania.

By 2009, almost 80% of KNM’s revenue came from its overseas operations, with Borsig making up half of it.

To fund the acquisitions, KNM racked up debt that grew to RM1.43 billion by end-2008 — a fivefold increase from the previous year. While net cash flow from operations doubled during the year, its cash flow over debt coverage weakened to only 0.08 times from 0.27 times in 2007.

But as the worst downturn since the Great Depression in the 1930s battered the global economy, KNM found itself with a huge debt pile as the process equipment market dried up, with oil majors refraining from investing in more refining capacity.

There was also the issue of financing its waste-to-energy (WTE) plant project in Peterborough, the UK, which was supposed to be one of the major projects to be built using Borsig’s expertise.

Announced in 2010, the RM2.2 billion project made up 43% of KNM’s order book at that time. However, construction only started recently and the group targets the plant to be up and running by June 2022.

It was a classic case of expanding too fast and bad timing.

Nevertheless, KNM weathered the storm. The group swallowed a bitter pill last year in recognising a one-off reversal of non-cash deferred tax asset (DTA) of RM346.64 million in an investment tax allowance previously granted in 2012.

In FY2018, KNM posted a net loss of RM871.6 million, partly due to the reversal of the DTA and higher impairment charges on its property, plant and equipment. This was a huge jump in losses from the RM49.4 million recorded in FY2017.

“Previously, because the market was good, we expanded and became oversized. Now that we have disposed of the subsidiaries that have been bleeding, we are at the right size now and ready to pounce on opportunities as demand returns,” says Lee.

The engineer by training is confident that the market for its process equipment is making a comeback as oil majors are ramping up investments in refineries and petrochemical plants as crude oil prices stabilise.

While greenfield mega refineries such as Petronas’ Refinery and Petrochemical Integrated Development in Pengerang are hard to come by, existing facilities need upgrading.

For example, Indonesia’ Pertamina has a US$4 billion budget to upgrade its refinery in Balikpapan. This is part of effort to upgrade all six of its refineries in Indonesia over the next eight years with a budget of US$30 billion.

“These upgrading works are substantial. We can see that major projects are coming in, not only in this region, but also in Kuwait, Abu Dhabi and Oman. Of course, there is also the Saudi Aramco refinery, which needs to be repaired and upgraded after being damaged,” says Lee.

Building up recurring income

During its restructuring process over the last five years, KNM took a conscious decision to bid for higher-margin contracts. Together with cost controlling measures, the group has managed to turn around its Asia and Oceania operations.

In 1HFY2019, KNM’s operations in Asia and Oceania recorded earnings before interest, taxes, depreciation and amortisation (Ebitda) of RM15.7 million, compared with a loss of RM27.4 million in the corresponding year.

During the period, the revenue of the Asia and Oceania operations hit RM153.45 million, which was about 74% of the segment’s total revenue in FY2018 of RM206.21 million.

Part of the increase in KNM’s Asia segment came from its bioethanol plant in Chachaengsao province in Thailand that started operations in July 2017. The plant currently produces 200,000 litres of bioethanol per day using tapioca as feedstock.

The plant was funded via an Asian Development Bank-backed bond of US$80 million raised in 2016.

KNM plans to raise the plant’s capacity to 500,000 litres per day and once it produces that much bioethanol, it will be profitable, says Lee.

“The good thing about this project is that it is a cash cow. We have very good list of customers with the biggest taker being Chevron, which is committed to take up 60% of our production over five years,” he notes, adding that the expansion plant will require an investment of US$60 million.

The Thai government gives producers a THB9 per litre cash incentive to produce the green fuel. At the same time, the price of fuel in Thailand, which largely reflects that of the international market, makes it viable to produce biofuel.

Besides that, KNM is also looking at opportunities to bid for WTE plants in Malaysia and Indonesia, says Lee.

The construction of its WTE plant in Peterborough has started, with the first phase targeted to be completed by June 2022. The plant will have a capacity to process 150,000 tonnes per annum of waste, and power-generating capacity of 11mw.

The group’s plans to grow its recurring income business will require a lot of funds. Its plans to expand its bioethanol plant in Thailand and build the first phase of its Peteborough WTE plant will need an investment of RM680 million.

If KNM wants to develop and own a WTE plant with a capacity to process 3,000 tonnes of waste per day, it would have to invest RM1 billion.

As at June 30, 2019, KNM’s debt-to-equity ratio stood at 0.96 times. Its cash and cash equivalents was RM367.91 million as at that date while short-term debt and borrowings amounted to RM401.19 million.

KNM is looking at monetising its investment in Borsig to fund its future growth plan, says Lee. Besides an initial public offering, the group is considering getting a strategic partner to take up a stake.

“The investor we want should be somebody that can help open up a bigger market for us. We want somebody who can bring in money and potentially open doors for us, bringing in new businesses,” says Lee.

KNM did not provide the financials for Borsig. However, in 1HFY2019, its European operations recorded an Ebitda of RM100.69 million, which was 87% of the segment’s Ebidta of RM115.6 million in FY2018.

Borsig has been profitable all these years as KNM’s other businesses were bleeding, Lee says. However, as the group’s total losses mounted, investors dumped the shares and thus undervalued Borsig.

Lee confirms the group will be looking, at the very least, at the same price — RM1.7 billion — that it paid for Borsig a decade ago. However, he believes the company is worth more than that for its good technology and strong brand value.

With all the plans lined up for KNM, sceptics and believers alike will be watching it closely.

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