KNM Challenge Limits

Borsig To Come In 2H

KNM’s 1Q08 earnings came in within expectations. Similar to last year, 1Q profits were typically weaker due to festive holidays. Operating margin improved to 19.5% vs 17.6% in the same period last year, indicating more higher-end process equipments were delivered. In 2H08, Borsig will start contributing to earnings and it is estimated that Borsig will bring in an additional RM260m net profit to the company on a full year basis. The acquisition is expected to be completed in the 1st week of June, with payment to be settled by a €450m bridging facility provided by Maybank. The subsequent RM1.1bn fund-raising exercise will be completed in mid- June hence there should be minimal risk for the deal. Our earnings estimates for FY08 and FY09 are based on the assumption of zero integration benefits. Synergies will likely come in only from 2010. Maintain Buy and RM8.40 fair value.

Earnings on track.

KNM’s 1Q08 net profits were inline with our estimates. Turnover and net earnings were 26% and 41% better than the same period last year. Besides the boost in profits from Borsig, the new capacity from recent acquisitions such as the Edmonton plant in Canada and Ellimetal in Belgium will start kicking in from 2H this year. Operating margins imrpoved. The continuous effort to fabricate more higher-value added process equipments has led operating margin to improve by 2%pt from 1Q07.

Status of Borsig.

Unlike the recent cancellation of the RM50m acquisition of Pisces, given the size of Borsig which worth RM1.67bn, we think this acquisition should have minimal risk. The €450m bridging facility provided by Maybank will be used to settle the payment which will be due in the 1st week of June. What is left is the US$350m exchangeable bond, which we believe may be denominated in Ringgit given its currency strength and domestic interest rate environment. Conversion ratio for the exchangeable bond could range from 1.3–1.4x.

Still a Buy.

We keep our earnings forecast unchanged. KNM could also potentially benefit from the tax re-investment allowance scheme in Malaysia. As such, Borsig’s typical 20% net margin generated in Germany previously can well be replicated. However, we have not factored in the lower tax rate, pending management’s guidance if the application is successful. Our FY09 fair value is on an ex-right basis, taken into account the dilution effects from rights and bonus issue as well as the exchangeable bond.

From: OSK Research 28 May 2008

Company Profile:

KNM Group Berhad was incorporated in Malaysia as a private limited company under the Companies Act, 1965 on 22nd July 2000 and was subsequently converted into a public limited company on 12th September 2000.KNM Group Berhad is principally an investment holding company while its subsidiary and associated companies are principally involved in integrated systems design and engineering, international procurement, manufacture of process equipments for the oil, gas, petrochemical and minerals processing industries, testing capabilities, site assembly, commissioning and maintenance.