This article first appeared in The Edge Malaysia Weekly on April 29, 2024 - May 5, 2024

MAIN Market-listed Kelington Group Bhd — seeing early signs of development amid the recovery of the semiconductor industry and intending to capitalise on potential demand for its ultra-high purity (UHP) gas solution from technology players — has positioned itself in Hong Kong and Germany to meet new orders. The move will enable Kelington to meet surging demand for chips, driven by factors such as the China Plus One policy and the need for advanced technologies like artificial intelligence, the Internet of Things, electric vehicles and Industry 4.0.

To facilitate the expansion into both markets, Kelington has incorporated Kelington Engineering (Germany) GmbH and Kelington Engineering (HK) Ltd as indirect wholly-owned subsidiaries.

In an interview at its headquarters in Kuala Lumpur, Kelington founding executive chairman and CEO Raymond Gan Hung Keng and chief operating officer Steven Ong Weng Leong tell The Edge that the group’s move to expand is partly a response to requests from its current multinational corporation (MNC) customers in Malaysia to set up in Europe, as well as to clinch new projects in Hong Kong and capitalise on its potential to be Asia’s next  research and development hub for semiconductors.

As such, the group is now bidding for projects in Hong Kong worth several hundred million ringgit, while looking out for potential jobs in Germany.

“We want to grow beyond our current coverage. We are venturing into Hong Kong as we are aware that some wafer fabs are being planned. Meanwhile, Europe is enacting its European Chips Act to protect the industry, which tells us there will be more wafer fabs to be built in the big European market,” says Gan.

He adds that Germany was chosen as the regional base for Europe, first because it has the highest number of wafer fabs and, secondly, at the prompting of Kelington’s key clients, which are MNCs in Malaysia, that they will ask the company to service their new facilities when they return to set up on the continent. He adds that the venture underscores the importance of wider geographical coverage for its operations to mitigate risks in the technology sector.

“We will be able to ride our current track record with them for future work,” Ong affirms.

He explains that the first few tenders in Germany, once they are secured, will be for Kelington to familiarise itself and execute in partnership with a local party to ease its navigation of the new territory.

“We expect orders in Hong Kong to come in sooner, within the second or third quarter as we are already tendering for a project worth several hundred million ringgit, whereas Germany will take longer — perhaps closer to the year end or early next year,” says Ong.

“The labour and contractor requirements in Europe will be different. What Kelington can offer [above prevailing market capabilities in Europe] is efficiency in cost and speed.”

The UHP business made up the lion’s share (74%) of the group’s FY2023 revenue, followed by general contracting (20%), and the process engineering and industrial segments making up the balance. It is noteworthy that a little more than a year ago, UHP projects made up about 50% of group revenue, and that was largely due to the sizeable construction project undertaken for a client in Kuching, Sarawak.

In the last five years, Kelington has seen significant replenishment of its order book, which totalled RM1.19 billion in 2021, RM1.85 billion in 2022 and RM1.1 billion last year.

Ong says the FY2023 order book of RM1.1 billion is evenly split between its clients in Malaysia, Singapore and China, and that it is “more than sufficient to make up this year’s revenue”.

Meanwhile, the industrial gas segment, with completion of its second carbon dioxide gas recovery plant in Kerteh, Terengganu, will be ramped up moving forward.

“Its contribution is relatively small, but we expect incoming jobs to contribute up to 50% of group revenue in the next four to five years,” Ong says of the segment, which is expected to have a higher gross profit margin of 30%. “We are now exploring a potential expansion of this business arm into Indonesia. Our engineering business, which is our cash cow, gives us a gross profit margin of 15%. What it generates goes into funding the industrial gas business, which will be our future star.”

“We believe that the semiconductor recovery this year will peak in 2025, leading to a good 2026. We expect many new projects to be launched very likely in the second half of this year,” says Gan.

To note, an indirect client of Kelington will be building a new fab foundry in Singapore, while key clients in China will be expanding their businesses, Ong shares.

The China Plus One policy undertaken by many companies will benefit Kelington as it expects the expansion of companies, which were supposed to be done in China, will take place in Malaysia and Singapore instead.

Addressing concerns of manpower and logistical matters, Gan assures that setting up in Hong Kong and Germany will require very little capital expenditure given the nature of the construction and installation jobs for UHP projects. Each project will only require engineering teams of seven to 10 persons per project for a duration of six to nine months from the point of the project’s award, he says.

“Our plan is to dispatch our team(s) from Singapore to Germany, and local staff to Hong Kong. We don’t need our own fabrication arm there. We need only assign engineers with the support of a few skilled welders and other supporting staff. Materials would be bought from Europe itself or elsewhere. Our expertise is in the assembling and installation,” Gan says.

When asked about competition in Europe, he explains: “Europe and the US lack this [skillset] as both have been ‘dormant’ in the last 20 years [where installation services for UHP is concerned]. A study of new wafer fabs being built will show that players in Asia-Pacific have had the highest semiconductor equipment spending — and that’s just a few countries, being Taiwan, [South] Korea, Singapore and probably China. And to an extent, Malaysia. There may be a few small investments towards fabs in Europe and US, but they are small for such sizeable regions. Outside of Taiwan, Malaysia and Singapore are known to have next to best skillsets in this field. This is our game.”

Gan and Ong explain that there are not many major engineering services players like Kelington in Hong Kong but there are more in Germany.

“Being an Asian company, we have certain advantages over the Europeans in cost and speed efficiency,” Gan emphasises, adding that the group is open to potential partnerships to strengthen its offerings in Germany and Hong Kong.

For the fourth quarter ended Dec 31, 2023, Kelington posted a two-fold growth in net profit of RM35.73 million compared with RM18.19 million a year ago on a 12% improvement in revenue to RM478.26 million.

Although Kelington’s revenue in FY2023 is more than four times what it was five years ago (see chart), Ong says the focus will be on growing the group’s net profit.

“In the last few years, we have experienced a double-digit or circa 20% growth in net profit as we established quite a large business base. We plan on maintaining double-digit growth, although it would not be 20%,” says Ong, without revealing the figure.

He adds that for FY2023, the group had net profit margins of 6% to 7%, which would be pushed towards the 7% to 8% level.

Kelington’s dividend policy of paying out at least 25% of its net profits had the group paying out annual dividends per share of up to 2.5 sen in the last six years, dipping to 1.5 sen during the pandemic.

As at Dec 31, 2023, the company had net cash of RM92.17 million and retained earnings of RM204.4 million.

“Depending on the strength of our cash flow, we would strive to declare higher dividends to our shareholders,” Gan says.

At its last price of RM2.59 a share last Thursday, Kelington was trading at a trailing and forward price-earnings ratio (PER) of 16.8 times and 14.97 times respectively.

Gan and Ong say that the group’s PER is not commensurate with its financial performance and future prospects, with Gan pointing out that Kelington’s share price fell during the tech bull run after the pandemic in spite of consecutive improvements in its quarterly earnings.

“[A valuation of] at least 20 times would be reasonable as 20 to 30 times would be a very aggressive target. But a PER of 17 times as valued by the market does not reflect the data [on financial performance],” says Gan.

Conceding that the valuation is “rather low with room to grow”, Kenanga Research analyst Samuel Tan rationalises that a positive sentiment for the semiconductor industry plays a major role in driving buying interest.

“Fundamentally, margin expansion will be another catalyst, and it is what the group is aiming for via its recently built liquid CO2 (LCO2) Plant 2, expanding capacity by 40%. Note that the LCO2 business commands twice the gross profit margin compared to its existing bread-and-butter UHP gas system business,” says Tan, who is maintaining an “outperform” call on Kelington with a target price (TP) of RM3.40. All four analysts on Bloomberg have “buy” calls on the stock with a consensus TP of RM3.20. 

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