Valuation / Recommendation

We have a SUBSCRIBE recommendation on Kawan Renergy with a FV of RM0.35 based on 13x FY25F EPS, translating to 17% upside to IPO price. Our target PE of 13x is in line with comparable peers’ average valuation. We believe the stock could re-rate in the near term on the back of: 1) Stronger orderbook win for its key engineering business; and 2) Successful bid for a new 2MW biomass plant.

Investment Highlights

RE projects driving growth. Since FY22, a new revenue segment focusing on renewable energy (RE) and co-generation plant projects contributed to Kawan Renergy’s growth, which accounted for 22-30% of total sales. As of March 2024, its unbilled order book stands at RM72.9m, of which RM51.8m is expected to be recognised in FY24F. The group is also tendering for four new projects - an IPE venture, a co-generation power plant, and two process plant projects - valued at RM113m total. We expect Kawan Renergy to secure more order books in the coming years, driven by the rebound in foreign direct investment into Malaysia and strong government initiatives for the RE sector.

Steady margins. Margins for each business segment have generally been improving over the years. Notably, margins for IPE and process plants have been quite consistent in the last two years (staying around 19- 24%), helped by increased job order uptake. Due to timing differences, margins for the RE segment had a big swing (6.8% in FY22 jumping to 36.8% in FY23), which averaged out to be about 17% if we combined both financial years. Normalising for this and also factoring margin improvement for the RE segment, we expect Kawan Renergy could achieve a blended gross margin of around 20% in our FY24-26F forecasts.

Growing recurring income. Kawan Renergy plans to grow its RE business by bidding for a new 2MW biomass plant (in 2Q24), as well as improving its existing Bercham plant. It is estimated to cost RM15m to construct the new biomass power plant, and RM2.5m for the Bercham plant improvement. At full capacity, we estimate electricity sales from these two plants can contribute up to RM10.2m in annual revenue (assuming a FiT rate of RM0.3880/kWh), representing 8% of its FY26 revenue. Assuming a decent PAT margin of 30%, we expect RE electricity sales could potentially contribute close to 20% of earnings in FY26.

Risk factors for Kawan Renergy include (1) Skilled labours; (2) Fluctuations in steel metal prices; and (3) Regulation compliances. Source: Company, Mercury Securities

Source: Mercury Securities Research - 13 May 2024