KNM Group: Peterborough project delayed

Date: 10/10/2011

KNM Group Bhd (Oct 10, RM1.20) Maintain underperform with fair value of 70 sen: Last week, KNM announced that it had been prompted by its client that the financial close of its UK Peterborough contract (worth RM2.2 billion) has been delayed to December. As such, the company believes it will be unable to meet its guided FY11 revenue of RM2.2 billion and earnings before interest, taxes, depreciation, and amortisation (Ebitda) earnings of RM270 million. The project involves the development of a biomass and waste recycling centre in the UK using high-end technology. KNM was awarded the engineering, procurement and construction (EPC) contract on Dec 21, 2010. We are not surprised by the announcement as we have noted that the project had yet to achieve financial close by August. The management had previously guided that it would likely be achieved in early 2HFY11. As such, we had postponed the project's earnings contribution to FY12 in our previous note (dated Aug 23, 2011). We reiterate our view that the stock will likely continue to report disappointing earnings. Moreover, it has significant exposure to Europe and the UK, which are at high risk of economic slowdown. As such, we foresee continual volatility in its forward earnings despite its order backlog of RM5.3 billion (of which half is made up of the Peterborough project). We estimate that the Peterborough contract accounts for around 80% of our core FY12 earnings per share (EPS). However, this is based on conservative assumptions that the company secures minimal new wins beyond the project within FY12 and Ebitda margins grow by one percentage point to 9.5% (from our 8.5% assumption for FY11). We maintain our FY11 to FY13 earnings estimates as we had already assumed: (i) the project would kick start in FY12; and (ii) lower than guided revenue and Ebitda earnings of RM1.98 billion and RM168.5 million respectively for FY11. However, we are removing our FY11 dividend per share assumption of two sen, as we believe the company is unlikely to pay a dividend under such difficult conditions. Upside risks to our view include: (i) better than expected margins for contracts executed in the latter part of FY11; and (ii) higher than expected contract wins moving ahead which will significantly increase revenue earnings. The stock has continued to negatively surprise the market, reinforcing our view that the stock deserves to trade at a discount to sector peers. We maintain our fair value of 70 sen per share based on nine times FY12 price earnings ratio. ' RHB Research, Oct 10 This article appeared in The Edge Financial Daily, Ocotber 11, 2011.