Expect Better Quarters Ahead
We lift our call on KNM Group to 5-STARS (Strong Buy) from 4-STARS (Buy) previously, with a higher 12-month target price or MYR1.00 (from MYR0.95).
We see signs of life in terms of orderbook replenishment for KNM, with orders totaling MYR400 mln coming in in the first two months of 2H09, vs. MYR300 mln achieved in the whole of 1H09. Hence, we think 2Q09’s relatively weak performance should represent the bottom for KNM, and we expect the company to deliver better numbers from 3Q09 onwards, providing the catalyst for an upward re-rating.
KNM reported 1H09 net profit of MYR169.9 mln (+13% YoY), on a 3.7% increase in revenue to MYR964.7 mln. The results made up 43% of our 2009 forecast, which we consider to be in line, as 2H09 is likely to be stronger for the group on increased billings, new contract awards and a pickup in activity.
QoQ revenue and net profit again contracted by 16% and 28% respectively, on lowered billings and EBIT margins. Lower tax rates helped to offset a weakerthan-expected topline. Profit margins, while in line with our previous assumptions, were mainly boosted by 1Q09 one-off gains. 2Q09 operating margin was lower than we had expected, due mainly to lowered revenue.
KNM’s Chad JV will net the company a USD220-mln (MYR790 mln) EPCC contract to build up production facilities in the Sedigi oilfield development. We acknowledge the higher country risk associated with the venture, but we takecomfort from management’s successful risk management track record with previous acquisitions.
Overall, we trim our 2009 earnings forecast by 5%, following a cut in our margin assumptions given the lower 2Q09 margins. We maintain our long-term positive outlook on KNM Group, as we believe orderflow will pick up again, driven by rising oil prices and as global demand recovers.
Order flow appears to have picked up in 3Q09, and this should drive a rebound in profits for 2H09 and 2010 onwards, and provide the impetus for a re-rating. The outlook for KNM remains upbeat, premised on our positive medium-term outlook on oil prices. We now value KNM based on its Malaysian peer valuations (vs. global peers previously) as we feel this is more reflective of KNM’s fair value. We note that global peer valuations have risen to 18x 2010 EPS, vs. 12.4x 2009 EPS previously. Nevertheless, we do not expect KNM to reach these levels, given its previous investor concerns on the forced-selling of shares pledged by management and its
smaller market capitalization. With domestic peers now trading at 8.6x 2010 EPS, and rolling forward our valuation base year to 2010, we raise our 12-month target price to MYR1.20 (from MYR0.95).
Downside risks include a prolonged weakness in energy prices, which may force cutbacks on capital expenditure by the oil majors, thus impacting KNM’s ability to sustain its orderbook. A related risk is the large value of goodwill that KNM continues to carry on its books from the Borsig acquisition. Finally, management/succession risk lies in the fact that Lee Swee Eng, KNM’s co-founder and managing director, has very much been the driving force behind KNM’s
success, in our opinion.