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This article first appeared in The Edge Financial Daily on September 23, 2019

Kelington Group Bhd
(Sept 20, RM1.32)
Maintain buy with a lower target price (TP) of RM1.58:
We remain upbeat on Kelington Group Bhd’s prospects following a recent meeting with its management. We trim financial year ending Dec 31, 2019 (FY19) to FY21 core earnings to reflect a potentially weaker order book replenishment rate.

 

Its new liquefied carbon dioxide (LCO2) plant, which will be commissioned by October, is earnings-accretive from the outset and expected to further strengthen margins. We roll forward our discounted cash flow (DCF) valuation to FY20 to better reflect the expanding contributions from the industrial gas segment.

The management expects LCO2 production to commence in late September or early October, which is slightly behind schedule. With 30% of the initial production off-take committed to by customers, the LCO2 plant is expected to be earnings-accretive from the outset.

Kelington intends to progressively ramp up production over the next four years, with the plant’s rated capacity at 50,000 tonnes.

We see significant scope for the industrial gas business to scale up, with Kelington emerging as a challenger to industry leader, Linde Malaysia.

Based on an indicative 30% gross margin, we project the LCO2 business to contribute some 11.6% of group core earnings in FY20.

The industrial gas segment (Ace Gases Sdn Bhd) should drive longer-term recurring revenue/earnings, with the management vying for higher-yielding on-site gas supply projects, on top of distributing and trading of specialty gases

New orders secured year to date (YTD) totalled RM227 million (-4% year-on-year), with its outstanding order book at RM312 million as at second quarter ended June 30, 2019 (2QFY19) (76% from ultra-high purity [UHP] projects).

The management highlighted the potentially weaker order book replenishment in second half of 2019 (2H19) due to the challenging operating environment and the slowdown in domestic projects.

As such, we think FY19 new orders are unlikely to surpass the record RM424 million achieved in FY18.

The impact should, nonetheless, be mitigated by higher margins derived from its Singapore UHP and process engineering (PE) jobs (53% of outstanding order book) and potential new renewable energy/solar projects in Taiwan. Revenue contributions from Singapore overtook China’s in 3QFY18, and comprised about 40% of 2QFY19 revenue (FY18: 32%).

Kelington’s gross margin widened to 16.8% in 1H19 from 14.5% in 1H18, and is projected to further strengthen with the commencement of the LCO2 business.

We lower FY19 to FY21 core earnings by 2% to 7% after imputing more conservative order book replenishment assumptions going forward.

Our DCF-derived TP is adjusted to RM1.58 from RM1.63, after rolling forward our base year to FY20.

Key risks are slower-than-expected order book replenishment, margin weakness, and management execution. — RHB Research Institute, Sept 20

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