KIAN ANN ENGINEERING - Margins holding up on strong demand (OSKDMG)

BUY

Price S$0.22

Previous S$0.31

Target S$0.31

Kian Ann Engineering’s (KA) 1QFY12 earnings were in line with our expectations. Earnings jumped 39.7% YoY, reaching S$5.3m, on the back of a 17.1% YoY leap in revenue. On the back of strong demand for spare parts, we forecast gross margin to come in at 28% in FY12, above its historical average of 25%. Trading at 5.1x FY12 earnings, we believe the stock is undervalued when compared against its construction-related and heavy equipment peers at 6.9x blended CY11/CY12 earnings. Based on a target P/E of 7x FY12 earnings (5-year historical average), we value KA at a TP of S$0.31, implying a 40.9% upside.

1QFY12 earnings within expectations. KA’s 1QFY12 earnings leapt 39.7% YoY to S$5.3m, attributable to a 17.1% YoY jump in revenue. 1QFY12 revenue grew on the back of higher sales from 1) Indonesia (+15% YoY), 2) Other Asian Countries (+30.3% YoY) predominantly due to an increase in demand of parts from China and 3) Non-Asian Countries (+57.6% YoY, largely on the back of growth from Russia and Oceania), hitting S$44.2m due to strong demand from the forestry, mining and infrastructure sectors.

Strong demand holding up gross margin. Following the 2008 global financial crisis, KA has seen greater demand for parts and selling prices have been raised. Consequently, gross profit margin expanded and remains relatively stable and higher than its historical average of ~25%, coming in at 28.4% in 1QFY12 (1QFY11 and FY11: 28.4%). This marks the sixth consecutive quarter that KA has enjoyed gross margins above its historical average. We believe this is an indication of the pent-up demand for KA’s parts and understand that margins are still holding up currently.

Focusing on emerging markets. As reflected from the geographical segmental growth in KA’s sales, it is now reaping the fruits of its labour from its efforts in penetrating the emerging markets. KA would continue to focus on growing its sales in markets like Indonesia, China and Russia. We forecast FY12 and FY13 earnings to come in at S$19.1m and S$21.1m respectively, on the back of sustained gross margin of ~28% and a 10% YoY increase in sales.