KNM Capital Sdn Bhd - 2009

MARC has affirmed its ratings on KNM Capital Sdn Bhd’s (KNMCap) RM300 million Murabahah Underwritten Notes Issuance Facility/Islamic Medium Term Notes (MUNIF/IMTN) at MARC-1ID /AA-ID. The outlook on the ratings is stable. KNMCap is a wholly-owned subsidiary of KNM Group Berhad (KNM) and serves as a funding conduit for the group. The ratings reflect KNM’s enhanced market position, good geographic and product mix, well-diversified end-market exposure, as well as its established track record with longstanding clients and resulting healthy order book. These have contributed positively to KNM’s financial profile, which is reflected by its stable earnings capacity and its healthy cash flow generation. However, the ratings are tempered by the integration risk posed by newly acquired businesses and weaker credit metrics during the immediate post-acquisition period.

KNM is an established manufacturer of process equipment for the global oil & gas, petrochemicals and minerals processing and many other industries. Its recent large acquisitions and strategic joint-ventures (JV), which notably includes Borsig Beteiligungsverwaltungsgellschaf GmbH (Borsig) of Germany and the HZM group of companies of Brazil, have, despite the general increase in the firm’s consolidated business and financial risk profile, afforded it some notable benefits. Its acquisitions in 2008 of Borsig and HZM provided the firm with opportunities to entrench itself in the global market. The wider market reach also allows KNM to cross-sell its products and capitalise on the synergies among the group’s various subsidiaries to achieve better cost efficiencies. KNM has also strengthened its technical expertise and technological capabilities through acquisitions and JVs, allowing it to produce a larger number of high-margin products.

Post-acquisition of Borsig, KNM’s order book as at March 31, 2009 stood at RM3.85 billion (March 31, 2008: RM4.5 billion), with approximately 34% contributed by Borsig’s own ongoing projects. Currently, KNM is participating in tenders of some RM16.6 billion worth of contracts. Based on KNM’s historical success rate, the replenishment of its order book is unlikely to be a major concern for the company.

KNM’s revenue doubled to RM2.5 billion in FY2008 compared to the previous year’s RM1.2 billion, helped by contribution from newly acquired Borsig as well as positive showing from KNM’s enlarged production capacity of high-end process equipment abroad. Its operating margin also widened to 20.2% against the previous year’s 18.3% due to a larger amount of high-margin contracts. Margins are generally expected to increase further supported by KNM’s focused shift away from lower-margin products towards the production of high-margin specialised equipment.

As at year-end 2008, KNM’s debt level increased to RM1,430.4 million from RM265.9 million in 2007, mainly as a result of borrowings taken to fund the Borsig acquisition. Its rights and bonus issue of RM725.3 million enlarged KNM’s share capital base to RM989.6 million (year-end 2007: RM261.6 million); this moderated the increase in its debt-to-equity (DE) ratio which rose to 0.8 times from 0.5 times a year ago. KNM’s net cash flow from operations has also doubled, increasing to RM174.3 million in FY2008 compared to previous year’s RM80.3 million, in line with its enlarged revenue base. Although its CFO debt coverage has weakened, having declined to 0.08 times from 0.27 in FY2007, MARC believes that KNM’s continued strong earnings should permit an incremental strengthening of its debt service coverages and deleveraging over time. However, the magnitude of its debt reduction will depend on the manner in which KNM manages its capital spending and acquisitions.

While KNM’s financial performance remains sensitive to the vagaries of the oil & gas industry, KNM’s good market diversity and competitive position in its established markets is expected to enable the group to maintain robust operating profitability and stable cash flow generation. Nevertheless, considering the group’s appetite for acquisitions, its ability to effectively manage its world-wide operations and fund future acquisitions without further deterioration of its balance sheet remain an important rating consideration.

Strengths

• Established business profile and broad product offerings
• Enhanced market position post acquisition
• Steady order book with reputable clients operating within the oil and gas and petrochemical industries; and
• Good financial profile as reflected by its higher earnings capacity, healthy operating cash flow and manageable debt levels.

Challenges/Risks

• Susceptible to vagaries of the oil and gas and petrochemical industries; and
• Integration of recent acquisitions and revenue generation from such operations, although not a major concern, still remains as an important challenge.