KNM Group Bhd - 2010

MARC has assigned ratings of MARC-1ID and AA-ID on KNM Group Berhad’s (KNM) up to RM400 million Islamic Commercial Paper Programme (ICP Programme) and up to RM1.1 billion Islamic Medium Term Note Programme (IMTN Programme) respectively. The outlook on the long-term rating is stable. KNM’s 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. The proceeds from the issuance of notes will be used to refinance KNM’s existing borrowings, retire the outstanding notes of wholly-owned subsidiary and funding conduit KNM Capital Sdn Bhd (KNM Capital) and to fund the group’s working capital and general expenses. The debt refinancings will help stagger, extend and align the group’s debt maturity profile with its operating cash flow generation. The stable rating outlook is premised on expectations of improved order book replenishment from FY2010 onwards, recovery in the group’s profitability and improved cash flow from operations, which should reverse the more recent weakening of its profitability and cash flow coverages.

A well-established manufacturer of process equipment, KNM serves a global client base that comprises companies in a number of industries, including the oil & gas, petrochemicals and minerals processing sectors. KNM’s revenue for FY2009 declined by 27% to RM1.8 billion compared to RM2.5 billion in FY2008, primarily due to its challenging business environment. Apart from lower sales volumes, profitability also declined as a result of pressure on margins caused by increased competition, particularly in the low-end to medium market segments, provisions for foreseeable losses in respect of its Canadian operations and lower plant capacity utilisation. Operating margins narrowed to 11.1% in FY2009 from 20.2% in FY2008. The group’s 1H2010 performance was also characterised by lower revenues and operating margins.

KNM has taken a number of strategic actions to improve its competitive position, increase its revenue potential and to restore its consolidated profitability and margins which have registered a downtrend over the past few quarters due to the challenging operating environment. To enhance the group’s ability to capitalise on opportunities in the power, green technology and biotechnology sectors, KNM has entered into joint-ventures with international companies. The group has also pursued cost-reduction initiatives and operational efficiency improvements. KNM’s order book of RM3.0 billion as at end-April 2010 (March 31, 2009: RM3.5 billion) provides sufficient near-term revenue visibility. Notwithstanding this, MARC is of the view that the group’s ability to stem and reverse sales and margin declines will be critical for a recovery in its revenue and earnings as well as credit measures over the intermediate term.

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 to a debt-to-equity (DE) ratio of 0.62 times compared to 0.79 times in the previous year. The improvement in the DE ratio was also a result of profit retention. Increases above current gearing levels could put pressure on KNM’s cash flow protection measures unless there is offsetting revenue growth that can match the debt servicing needs of the additional debt assumed. A higher gearing level will also increase the group’s vulnerability to material deviations in earning and cash flow generation targets. The current rating level assumes that the group will pursue its near-to-intermediate term growth objectives in a balanced manner that recognises the need to maintain key credit protection measures at levels which remain supportive of assigned ratings.

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 arising from the implementation of milestone billing. KNM’s CFO debt coverage and CFO interest coverage improved from FY2008 levels to 0.3 times (FY2008: 0.1 times) and 7.0 times (FY2008: 3.1 times) respectively but its CFO subsequently turned negative in 1H2010. KNM’s CFO for the first six months of 2010 was impacted by its weaker earnings performance. The group’s more manageable debt amortisation profile post-issuance of the new facilities will benefit KNM’s cash flow and is expected to support reasonable covenant headroom in respect of its minimum covenanted finance service coverage ratio (FSCR) of 1.5 times under the debt programmes.

Strengths

Challenges/Risks