May 10, 2010

KNM Upgraded to Buy

Price 0515  Target Price: 0.68

Attractive valuations, improving operations

Tactical upgrade to Buy with a 32% upside to TP, following a 30% correction in share price since the failed takeover exercise in mid-Apr. We believe most of the negatives have been priced in and fundamentals are set to improve. There is limited downside from here but share price recovery may take awhile, potentially depressed by earnings disappointment, external issues and reputation concerns. Our unchanged TP is based on 9x 2011 EPS.  

Most of the negatives priced in. Share price has underperformed the KLCI by 29% since Group Managing Director, Ir Lee Swee Eng (LSE) and his collaborators (GS Capital Partners VI Fund L.P. and Mettiz Capital Limited) aborted the takeover in mid-April. The penalizing runalso took a hit on reputation and credibility, and in anticipation of weak earnings ahead in 1Q10 results. Foreign shareholding has fallen to below 20% versus its historical high of 36% in Apr 2010. 

Positives emerging. 2010 earnings are not likely to be inspiring (flat at best) as KNM suffers from falling orders as it carries  out sub-quality, razor thin margin projects. However, market has to look beyond 2010. Operationally, contracts are flowing again with job enquiries rising and oil prices stabilizing. Replenishment risk is abating and order book revival is expected to kick-in by 2H10. With the sector at the cusp of recovery, we should see the bottom in earnings. Profits are expected to return to pre-crisis level by 2012 once these inferior jobs phase out. 

New Offer?
We do not rule out a new Offer, based on the depressed share price and the fact that no formal offer has previously been made. The previous offer failed due to an unattractive offer price, allegedly  equivalent to RM0.60-70/sh (1-year 8x EV/EBITDA), which was 22-33% below the initial RM0.90 offer. At RM0.51, this attracts a 18-37% premium to the ‘new price’. Its recent share buyback exercise (16m @RM0.51 YTD; 74.1m shares under treasury) signals undervaluation whilst its current net gearing level of 36% allows KNM an eye on M&A. 

Valuations are inexpensive.  We think valuations have turned very undemanding  with the steep correction in  price. At current price of RM0.51, KNM is only trading at 1x 2010 book, and 6-11x PE multiples for 2010-12. These valuations are comparatively low vis-à-vis regional peers’ valuations of 3x P/B and 15-24x PER. They also reflect KNM’s near bottom of cycle valuations (now below its SD of historical mean). 

by Maybank IB