9 November 2020

Buy with 51% upside. Kelington Group Berhad (KGB) provides ultra-high purity gas delivery systems used in wafer foundries, which are currently being thrusted into the limelight given record-high FDIs, imminent wafer shortages (thus requiring further expansions) and China’s semiconductor localisation efforts. With Biden winning the US election, we believe sentiment overhang on SMIC and hence KGB is now cleared. In addition, we believe market is grossly underestimating KGB’s earnings potential as the stock only trades at 15.6x Fwd. PER, significantly cheaper than peers’ average of 30-58x. Initiate with OUTPERFORM and TP of RM1.92.

Biden wins, KGB wins? Recall that KGB’s share price has been under pressure due to concerns of the US banning SMIC which is KGB’s biggest ultra-high purity (UHP) gas client. Now with Biden winning the US presidential election, such sentiment overhang is cleared. More so as the Democrats have not gained full control of the Senate, making harsh policies on China tech companies difficult to be imposed. SMIC has more than tripled its capex budget from US$1.9b last year to US$6.7b in Aug 2020 for expansion as its existing capacities are already filled to the brim. Hence, KGB is primed to benefit from the massive expansion plan.

Record high FDIs to translate into jobs next year. Total investment in Penang almost tripled to a record high of RM16.9b in 2019, and momentum continued into 1H 2020 with RM9.1b. Notable foreign direct investment (FDI) include projects from Intel, Lam Research, Bosch, and B Braun. Typically, once FDIs are announced or approved, UHP gas contracts will be awarded in the next 1-2 years, which is happening currently. From our recent checks, KGB has already started winning jobs from such multinationals, and we believe there are more to come. Regionally, Digitimes also highlighted a severe wafer shortage of 20% next year, which signals that foundry expansion will continue, benefitting KGB.

Orderbook at all-time high. Backed by prospects mentioned above, KGB’s orderbook surged to a record high of RM386m (including RM61.8m awarded by SMIC recently) from RM258m at end-FY19. This means that there is a huge backlog of jobs for KGB to deliver as Covid-19 situation improves. Operations are fully back online in Malaysia, China and Taiwan, while its Singapore operation has recovered from 30% to 75% recently.

Earnings potential grossly underestimated. We believe KGB’s earnings potential in FY21 is being underestimated by market, which is only looking at RM17.9m. To put things into perspective, KGB already achieved PAT of RM24.4m in FY19 even with ~RM1m start-up losses for its liquid CO2 plant and ~RM2m idling losses at Taiwan division. For FY21, we forecast the liquid CO2 plant to start generating RM3-4m profit, while Taiwan also swings into profit of RM2m. With its all-time high orderbook, we believe we too are still being conservative with our FY21E PAT of RM26.0m (+230% YoY).

Initiate with OUTPERFORM and Target Price of RM1.92, based on FY21E PER of 23.6x (+0.5SD from 3-year mean). The stock currently trades at FY21E PER of 15.6x, significantly cheaper than peers’ average of 30-58x.

Risks to our call include: (i) Slower-than-expected revenue recognition due to Covid-19, (ii) downturn in semiconductor sales, and (iii) delay in liquid CO2 ramp up.

https://drive.google.com/file/d/1OEP_ZItmVDbpebkrCfzUSfaKxutt9l-S/view