KNM Capital Sdn Bhd - 2010

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 and the funding conduit for KNM Group Berhad (KNM). The ratings reflect the group’s strong market position, well-diversified product offerings and geographical locations, broader market exposure, as well as the group’s healthy order book. KNM’s credit quality remains appropriate at this point in its business cycle although its cash flow coverages are somewhat weak for its current ratings as a result of its debt-funded business acquisitions and heavy debt amortisation schedule in the near-to-intermediate term. The stable outlook is premised on MARC’s expectation that KNM has the capacity to regain its earnings momentum and will work proactively to lengthen its near-to-intermediate debt maturities in order to ensure its credit metrics remain consistent with its assigned ratings.

KNM is an established manufacturer of process equipment for the global oil & gas, petrochemicals and minerals processing industries. The group is now positioning itself to tap into other sectors such as turnkey solutions, power plants and green technology/biotechnology. KNM’s growth strategy has entailed joint-ventures with other international players. Meanwhile, KNM continues to consolidate and streamline operations across its global manufacturing plants to improve cost efficiencies. MARC sees the realisation of cost efficiencies in these operations as crucial in a challenging environment characterised by fewer contracts volumes and lower margins, as experienced in 2009.

KNM’s order book as at end-April 2010 is valued at RM3.0 billion (March 31, 2009: RM3.5 billion). MARC believes that timely contract replenishment is required to restore revenue generation to pre-economic slowdown levels as well as to ensure adequate utilisation of the group’s plant capacity. KNM’s revenue for FY2009 was down by 27% at RM1.8 billion compared to RM2.5 billion in FY2008. Profitability also declined as a result of lower volumes and provisions for foreseeable losses in respect of its Canadian operations. Operating margins also declined in FY2009 to 11.1% from 20.2% in FY2008 due to lower margins on sales of products, particularly in the low-end to medium market segments and as a result of lower capacity utilisation of KNM’s plants.

As at year end December 31, 2009 (FY2009), KNM’s debt burden declined to RM1.2 billion from RM1.4 billion at end-2008 as a result of scheduled repayments during the year. The lower debt of the group translated  into a debt-to-equity (D/E)  ratio of 0.62 times  compared to 0.79  times in the previous year. The improvement in the D/E ratio was also supported by KNM’s profit accumulation. While MARC takes note of KNM’s fairly strong cash position and manageable debt level at this juncture, the rating agency believes that the group has limited headroom at its current rating level for additional leverage unless this is fully supported by additional earnings and cash flow.

Meanwhile, net cash generated from operations increased substantially to RM497.1 million in FY2009 (FY2008: RM283.0 million) as a result of higher collections during the financial year with the implementation of milestone-driven billing. Although KNM’s CFO debt coverage and CFO interest coverage improved from FY2008 levels to 0.3 times (FY2008: 0.1 times) and 6.7 times (FY2008: 3.1 times) respectively, upcoming debt maturities in subsequent years indicate a need for repayments to be realigned with its long-term cash generation ability. In the near term, financial flexibility is provided by RM300 million of available trade lines and an option to extend the tenure of a large bank facility. MARC draws comfort from the management’s commitment to address its longer-term debt service coverage levels. 

MARC will continue to monitor KNM’s progress with respect to initiatives taken to lengthen its debt maturity profile. The rating and/or the outlook may come under pressure if debt protection coverage ratio weakens below the minimum debt service coverage ratio covenant of 1.5 times.

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