New gas business seen to diversify Kelington’s earnings

This article first appeared in The Edge Financial Daily, on March 16, 2020.
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Kelington Group Bhd
(March 13, 96.5 sen)
Maintain buy with a lower target price (TP) of RM1.32:
Management remained cautiously optimistic during the recent post-financial year ended Dec 31, 2019 (FY19) earnings briefing. We think the worst case impact of the virus outbreak in China is likely behind Kelington Group Bhd. Revenue visibility for FY20 is decent, supported by a RM363 million order book and the new gas business. The stock’s selldown offers a great opportunity to accumulate, as the counter is trading at one standard deviation (SD) below its historical five-year mean.

Management highlighted that the impact to the supply chain from the Covid-19 pandemic has been minimal, and its China unit is rapidly returning to pre-pandemic levels. Preventive measures in place could result in some pushback in lead times, but this is not a material concern, as projects are just delayed and not cancelled. Kelington is monitoring its inventory levels closely due to the escalation of cases in Japan and South Korea, which could lead to near-term cost spikes. In our Feb 27 report, we highlighted that orders from Malaysia and China should stay fairly steady despite supply chain disruption concerns.

Its year-to-date new contract wins stand at RM105 million. This includes base-build and hook-up jobs for Semiconductor Manufacturing International Corp (SMIC) in China valued at RM64 million, and a contract from a leading international semiconductor multinational corporation in Penang (RM20 million). Given the additional scope of work from SMIC, management does not rule out further contract wins in the near term. Despite the weaker order replenishment, Kelington’s outstanding order book of RM363 million (end-February) should still keep the group busy for FY20, providing revenue visibility and a good degree of earnings certainty.

The utilisation rate of its Kerteh industrial gas plant has reached 45% (up from 40% a month ago), which is consistent with our forecast of a 50% offtake on average for FY20 (excluding new contracts in the food and beverage [F&B] segment). The company has successfully obtained the liquefied carbon dioxide (LCO2) International Society of Beverage Technologists-grade certification, and is now vying for halal certification before approaching F&B firms. We believe the LCO2 contract for the F&B segment could well come on stream by the fourth quarter of 2020, with Kelington looking to supply 15-20 million tonnes of the about 50 million tonnes of LCO2 consumed daily by the F&B industry.

Our discounted-cash-flow-derived TP drops to RM1.32 after imputing a higher risk premium assumption amid the cautious backdrop.

We still like Kelington for its expertise and niche exposure to the fast growing ultra-high purity segment. The new gas business offers earnings diversification and should help fuel the double-digit three-year earnings per share compound annual growth rate. Downside risks include slower-than-expected orders, margin weakness, and execution. — RHB Research Institute, March 13