GKE Corporation - SAC Capital 2021-06-08: Cementing Position As Warehousing Provider And Concrete Producer


GKE Corporation - Cementing Position As Warehousing Provider And Concrete Producer

Warehousing & logistics solutions provider in Singapore

  • GKE Corporation (SGX:595)’s warehousing and logistics segment provides end-to-end logistics solutions and services. These services comprise receiving cargoes at destinations, freight forwarding, providing storage and inventory management warehouses, project logistics management and arranging for delivery in Singapore and around the world.
  • GKE’s customers come from a wide array of industries, including manufacturing, food and beverage, oil & gas, chemical and pharmaceutical companies, among others. GKE seeks to value-add by providing a full-stop service, translating to higher efficiencies for customers.

Infrastructural materials and services supplier in China

  • GKE’s infrastructural segment focuses on the supply chain of infrastructural materials (ready-mixed concrete) and services, targeting mainly the private infrastructural, real estate development, and construction sectors in China, specifically, in Wuzhou and Cenxi.
  • Wuzhou Xing Jian, together with the new Cenxi Xing Jian (~80km from Wuzhou) that would be operational later this calendar year, is primarily engaged in the manufacturing and supply of ready-mixed concrete (RMC) in Wuzhou and Cenxi cities respectively.
  • Through Wuzhou Xing Jian, GKE also has:
    1. A 24% stake in Cenxi Haoyi Recycling, which recycles construction material waste; and
    2. Ownership of mining rights for 9.5 years (starting May 2019) which allows GKE to receive RMB3/tonne of limestone output produced and sold by its joint venture partners. This provides recurring income for GKE.

Good 1HFY21, stellar results expected for FY2021

  • GKE reported a 9.2% y-o-y increase in revenue to S$60.1 million in 1HFY21 ending 30 Nov 2020. This was mainly due to higher revenue contributed by Wuzhou Xing Jian RMC plant, coupled with an increase in storage revenue from the logistics segment due to Covid stockpiling. PATMI surged by 3.6x to S$6.5 million due to improvements in margins, which we believe can be maintained going forward. Overall gross margin rose from 18.6% in 1HFY20 to 24.2% in 1HFY21.
  • For logistics segment, which has high fixed costs, stockpiling has increased utilisation rates which will give economies of scale and bring down unitary costs. We expect FY2021 to see higher segmental margins from logistics.
  • Infrastructural segment brings in higher margins and has been seeing double-digit y-o-y revenue growth. With the Group’s the third line of production in Wuzhou and Cenxi’s new plant expected to be operational in 2HFY22, differences in revenue contributions of both segments will narrow further, improving Group margins going forward.

New RMC plants increase total capacity to 1.6 million m3

  • GKE expanded capacity of its Wuzhou Xing Jian RMC plant by 400,000m3 per annum in September 2020, bringing total production capacity of Wuzhou’s plants to 1.2 million m3 per annum.
  • Construction of the new Cenxi Xing Jian RMC plant (~80km from Wuzhou) is also almost completed, and would see production capacity of 400,000m3 per annum, which would contribute more substantially to 2HFY22 results, as we anticipate some downtime is needed for testing.
  • Wuzhou Xing Jian and Cenxi Xing Jian have a total fleet of around 40-50 mixer trucks. Management guided that the current utilisation rate for their plants is ~50%, which means output can be raised. Trucks can be leased to accommodate to short-term fluctuations in demand.

China’s urbanisation plans to be tailwind

  • Rapid urbanisation plans in Wuzhou to upgrade the infrastructure of the city will support the demand for GKE’s infrastructural segment. The urban development plan for Wuzhou includes property development, better roadway connectivity, and potentially to also build the city into a logistics hub.
  • This long-term plan is expected to continue to last at least until the end of the decade, seeing that Wuzhou is still largely underdeveloped compared to many other parts of China. This will create a sustained demand for ready-mixed concrete as it is one of the building blocks for construction.
  • In addition to Wuzhou, GKE’s new RMC manufacturing plant in Cenxi will add to revenue with its ~30% addition to production capacity, after construction and testing is completed.

Indoor farming as a small diversification

  • GKE Agritech is GKE’s wholly-owned subsidiary for indoor farming. Management said the idea came about after the importance of self-sufficiency of food became glaring during our Circuit Breaker in Singapore last year. GKE Agritech obtained the farm license from SFA in March 2021, which allows them to grow and sell its produce (only Kale currently) commercially in Singapore.
  • GKE converted its office premises at 6 Pioneer Walk into an indoor farm with a cultivation area of 2,400 sq ft, and target to expand to 12,500 sq ft. Although this is profitable, given the small scale, we do not expect operations to materially add to Group’s profit.

Initiate coverage on GKE with a BUY rating, at fair value of S$0.163

  • Our DCF-derived target price translates into a FY21E/FY22E P/E of 10.7x and 10.4x respectively. We expect China’s urbanisation plans to continue to drive demand for RMC. Addition of Cenxi plant would increase capacity by 30%, which would lift infrastructural segment contribution and hence Group margins.
  • Our target price implies a 21.6% upside to the last traded GKE Corp's Share Price.

Financial Summary

Stellar results expected for FY2021

  • GKE recorded a 9.2% y-o-y increase in revenue to S$60.1 million in 1HFY21 ending 30 Nov 2020, mainly due to higher revenue contributed by ready-mixed concrete manufacturing plant of Wuzhou Xing Jian, coupled with an increase in storage revenue from the third-party logistics segment with higher utilisation of space. PATMI surged by 3.6x to S$6.5 million, from S$1.8 million, due to improvements in margins.
  • Previously in FY2020 (ending 31 May 2020), the logistics segment grew 10.4% y-o-y to bring S$70.4m in revenue, contributing 65.6% to total revenue. However, this only made up 20.0% of profit before tax (PBT), giving a PBT margin of 2.6%.
  • Infrastructural segment, comprising largely ready-mixed concrete (RMC) supply surged 50.7% y-o-y in FY2020 to bring S$36.9m in revenue, but contributed 80.0% to PBT. PBT margin of infrastructural segment was significantly higher at 19.6%. We expect net margins of the segment to remain higher than logistics.

Overall gross margin likely to improve

  • GKE's gross margin improved from 18.6% in 1HFY20 to 24.2% in 1HFY21, mainly due to
    1. an increase in contribution by infrastructural segment (to ~40% of revenue in 1HFY21, from 34.4% in FY20) which generally has higher margins comparatively; and
    2. higher utilisation of warehousing space for the logistics segment.
  • For logistics segment, which has high fixed costs, stockpiling has increased utilisation rates which will give economies of scale and bring down unitary costs. We expect FY21 to see significant improvements in margins.
  • Infrastructural logistics segment brings in higher margins and has been seeing double-digit y-o-y growth in topline, thanks to the urbanisation projects in China. With GKE’s new cement plant up and running in Wuzhou, and Cenxi’s to be expected to be up in 2HFY22, we expect that differences in revenue contributions of both segments will narrow further as infrastructural segment’s rise in FY2022. Overall margins are likely to increase.

Turnaround year with positive accumulated earnings

  • During 1HFY21, the net cash generated from operations amounted to approximately S$11.1 million, up from S$2.6 million. Overall increase in cash during the HY was S$4.4 million.
  • Accumulated losses from previous years reversed. As at May 2020, accumulated losses was S$6.3 million, which their 1HFY21 results more than netted off, to give a retained earnings of S$0.3 million. FY2021 is a turnaround year for GKE as they start to enjoy positive retained earnings from their business operations.
  • We expect lower net gearing ratio going forward as the GKE generates higher cash flows.

Marquis Services became wholly-owned subsidiary

  • GKE bought the remaining 30% stake in Marquis Services Pte Ltd, a specialty chemicals storage and management specialist that handles chemical products and flammable materials. It also does industrial coating blending services and marine support services. GKE paid S$2.7m for the acquisition, with net tangible assets of Marquis sitting at S$5.5m.
  • Marquis has been a profitable subsidiary and the acquisition of stake will positively add to GKE’s result under the logistics segment. This also adds to recurring income as contracts for Marquis with its customers are usually locked in for a period of 2 years, and marine logistics businesses have lower competition due to its harder penetration.

Sale of Van der Horst

  • Sale of 65% stake in Van der Horst subsidiary is expected to increase cash at bank by RMB 58.5 million (~ S$12.2 million) over 3 tranches, of which, GKE received a total of 50% to date. The remaining 50% will be collected within the next year.

Tax rate to stabilise

  • GKE saw high tax rates in FY2020 due to the high non-deductible expenses, and losses from some entities in the Group. In addition, the higher China corporate tax rate, with an additional VAT element led to a higher Group effective tax rate. However, the effective tax rate had dropped from 47.7% in 1HFY20 to 30.3% in 1HFY21, mainly due to the higher profit from subsidiaries in Singapore. We expect tax rate to normalise to ~30% for FY2021 and stabilise going forward.

Dividend policy

Lim Li Jun Tracy SAC Capital Research | https://www.saccapital.com.sg/ 2021-06-08
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