GKent announced its intention to acquire a 40% stake in a JV for glove manufacturing purposes. The plan entails a production capacity of 12bn pieces p.a. in two years. Arrangement will see an award for construction of factory to GKent worth RM624m (RM213m for infra & building works). While the glove venture sounds lucrative, we are cautious on account for execution and market risks such as: (i) ongoing capacity expansions by incumbents, (ii) supply demand dynamics post mass vaccination, (iii) lacking prior glove expertise and (iv) factory construction risks. Increase FY22-23 earnings by 8% excluding glove venture contributions for now. Maintain HOLD with higher TP of RM0.85.

NEWSBREAK

Getting busy. GKent has been invited to acquire a 40% equity stake in Dynacare Sdn Bhd., a wholly owned subsidiary of Johan Holdings (related party) which will undertake gloves manufacturing. The stake will cost GKent RM40m to be funded by internal cash and bank borrowings. For perspective, GKent’s net cash position (including financial assets) currently stands at RM154m. The venture requires shareholders’ approval to diversify its principal activities as management expects the new business to form >25% of its earnings going forward.

Arrangement details. As part of the agreement, the JV will award GKent a contract carrying a global contract sum of RM624m (RM374m external). Under the contract, infrastructure and utilities portion is worth RM213m while the remaining RM411m is for machines and equipment. Manufacturing facility will sit on 18 acres of land located in Sitiawan, Perak. We understand SPA has been signed and would cost RM27m (inclusive of 5 factory buildings). As for the construction period, GKent plans to start work in July-2021 completing the facility by July 2023. This marks GKent’s first construction contract since 2016.

Glove venture. The JV intends to install 42 production lines in the next two years to manufacture latex and nitrile gloves to the tune of 12b pieces p.a starting with six lines operational by Dec-2021 (first line starts in 1st August-21 with additional line coming online each month). The remainder will be sequentially operationalised in 2022 and 2023. Markets in focus include Malaysia, US and EU. The group intends to submit and obtain approvals from the relevant authorities by 4QCY21. Based on assumptions of USD50/1k pieces, 80% utilisation, 15% net margin and effective capacity of c.1.25bn pieces in FY22 and USD/MYR4:1, earnings contribution could come in at c.RM96m for FY22. (1.7x of our FY22 forecasts).

HLIB’S VIEW

Replenishing thin orderbook. We are comforted by this construction orderbook replenishment arresting the immediate ex-LRT3 orderbook decline post-CY21 (hospital projects to complete by 2021). The job brings orderbook ex-LRT3 to RM784m lasting the next two years (note that RM411m is not civil, mechanical or electrical in nature). Nonetheless, we note that this “RPT job” should not lead to a recurring source for jobs moving forward nor does it indicate a material change in construction replenishment prospects beyond the said job.

Using idle cash. While we are positive on GKent’s deployment of idle cash to secure new earnings stream, we are cautious on its gloves prospects as a new entrant into a crowded space especially considering: (i) ongoing capacity expansions by incumbents, (ii) supply demand dynamics post-vaccine rollout, (iii) lacking prior glove expertise and (iv) construction risks.

Forecast. Increase FY22-23 earnings by 8.9% and 7.8% after accounting for the new construction contract. We exclude contribution from glove JV for now pending further notable execution of the plans.

Maintain HOLD, TP: RM0.85. Maintain HOLD with higher TP of RM0.85 post earnings adjustment. TP is derived based on FY22 EPS pegged to 8.0x P/E multiple. While we note the potential earnings upside from the new venture, we reckon execution of the proposal remains paramount with key risks as highlighted above.

Source: Hong Leong Investment Bank Research - 30 Mar 2021