KNM Bhd
(Sept 7, RM0.70)

Maintain hold at target price of 88 sen: Borsig’s indicative listing valuations of RM1.8 billion to RM1.9 billion or 10 to 12 times price-earnings ratio (PER) for the financial year 2013 (FY13) are fair in our view, pricing Borsig at 6% to 12% above KNM’s acquisition cost.

The move will  unlock value at Borsig; listing proceeds will be used to fund KNM’s Peterborough renewable energy venture. While this is positive, sentiment on the stock is still weak due to legacy issues. The successful execution of Peterborough would be a major catalyst. Maintain “hold” and RM0.88 target price (TP) (eight times FY13 earnings per share).

KNM has proposed to list its 100% owned Germany-based Borsig on the Singapore Exchange’s Main Board. The listing valuation for Borsig is at a slight premium to KNM’s 2008 RM1.7 billion purchase price. This pegs Borsig at an FY13 PER of 10 to 12 times, on a projected net profit of RM150 million to RM180 million. Borsig has been KNM’s core earnings generator since 2008, with net profit of RM112 million to RM141 million per year over the past three years.

The IPO could raise RM450 million to RM475 million for KNM, assuming it divests 25% of Borsig. We are of the view that the proceeds from this listing would be timely to fund the equity portion of its waste-to-energy power plant venture in  Peterborough,  UK. This build-own-operate project, which will cost about RM2.1 billion, should commence construction in 2013. We gather that KNM has secured financial closure for this deal. KNM will lead this project, in which it has an 80% stake.

The Peterborough project, if executed well, will provide KNM with a steady income from 2016 and transform its currently  purely cyclical business model. On paper, the Peterborough project has an equity internal rate of return (IRR) of 23% over 25 years, which would provide KNM with a projected revenue of RM225 million per year. There are execution risks as this project has yet to start construction.

The divestment of Borsig would lower our FY13 to FY14 net profit estimates for KNM by 17% to 31% based on a residual 75% stake. We maintain our forecasts for now.

While Borsig’s listing would address funding for the Peterborough project, the stock is not due for a re-rating until further signs of operational improvements and the paring of risks for the Peterborough project. — Maybank IB Research, Sept 7.

This article is appeared in The Edge Financial Daily on 10 September, 2012.