Industry Overview

11. INDEPENDENT MARKET RESEARCH REPORT 11. INDEPENDENT MARKET RESEARCH REPORT
(Prepared for inclusion in this Prospectus) Vit. F.,ot’ e-.ttIltI ~ IIhd. IComjJallV No: 1867f7·no VITAL FACTOR CONSULTING 75C & 77e Jelel”l 5522/19Creating Winning Business Solutions Damal”lsara Juye 47400 P&ulling Jaye Seillngor Darul EhSlll”l, Malaysia Tel 1603)77280248 Fa” (603) 7728 7248 16″ June 2003 The Board ofDirectors KNM Group Berhad 15, lalan Dagang SB 4/1 Taman Sungai Besi Indab 43300 Seri Kembangan Selangor Darnl Ehsan Dear Sirs Assessment o(the Manufatlu..-e of P..-ocess Equipment for the Oil, Gas and Petrochemical Industries The following is an extract of the Independent Assessment of the ManufacMe of Process Equipment for the Oil, Gas and Petrochemical Industries prepared by Vital Factor Consulting Sdn Bhd for inclusion in the Prospecrus of KNM Group Ikrhad (KNM Group) in relation to its listing on the Second Board of the Kuala Lun~ Siock Exchange. 1. Background • KNM Group’s core business is in design and engineering. international procuremtnt. manufacturing, shop fabrication, assembly. commissioning and maintenance of Process Equipment for the Oil, Gas and Petrochemical Industries.
• Some of KNM Group’s major products include process vessels, storage facilities, Liquefied Petroleum Gas (LPG) rnoWlded bullets, heat exchangers and air coolers, specialised piping system, process skid packages, flare stacks, specialised steel structural systems, revamped and maintenance ofrefrneries and process plants.

2. Overview of the Process Equipment for the Ol~ Gas and Petrochemical Industries
• The Manufacture of Process Equipment for Oil, Gas and Petrochemical Industries playa significant role in supporting the growth and development of Malaysia’s Oil, Gas and Petrochemical Industries.
• Process Equipment is used in the production, refining and processing of crude oil, natural gas and odler petrochemical products, Equipment such as reactors. distillation colwnns, separators, pressure vessels and heat exchangers are often regarded as the heart ofthe oil refinery or gas processing plants.

3. Government Legislation, Policies and Incentives • Apan from the nonna! manufacturing licen~, tbClt’ are no material govenunent laws, regulations and policies thai may in1>ede on the performance and growth of operators within the industry. 11. INDEPENDENT MARKET RESEARCH REPORT (Cont’d) o VITAL FACTOR CONSULTING Creating Winning Business Solutions Government Incentives and Protection • The Machinery and Equipment Industry Group, in which Process Equipment is a part of it, has been identified as one of the areas of priority for further development in the Second Industrial Master Plan 1996-2005. (Source: Second Industrial Master Plan 1996 -2005, Ministry ofInternational Trade and Industry Malaysia).
• The manufacture of mining or mineral processing machinery and equipment are regarded as promoted activities and are therefore eligible for Pioneer Status and Investment Tax Allowance llllder The Promotion of Investments Act 1986. (Source: Malaysian Industrial Development Authority)
• Heat treatment is classified under supporting products/services, which is undertaken by KNM Group in-house, is also a promoted activity under the Promotions of Investments Act (Source: Malaysia Industry Development Authority).
• Duty and tax exemptions on the import of raw materials for the manufacturing of Process Equipment, particularly for those that are not manufactured locally, are reviewed on a case-by-case basis. Thus far, the Malaysian Industrial Development Authority has approved KNM Group’s request for duty and sales tax exemption for the import ofits raw materials.
Implication
• The above demonstrate the priorities that Malaysian Government has placed on the Process Equipment Industry, and will ensure that the industry is nurtured and developed to its fullest potential.

4. Barriers to Entry • Barriers to entry into the manufacture of Process Equipment for the Oil, Gas and Petrochemical Industries is moderate to high and will depend on the type of projects as follows: Barriers to entry for small and medium-sized projects are moderate as indicated by the thirty to fifty manufacturers for this category ofprojects; Barriers to entry for mega-sized projects are high as indicated by less than ten manufacturers for this category of projects; Barriers to entry for projects requiring design and engineering capabilities are high as there are relatively few manufacturers with in·house design and engineering skills (Source: Primary Market Research undertaken by Vital Factor Consulting). • As the design, engineering and manufacturing of Process Equipment for Oil, Gas and Petrochemical Industries is very specialised due to stringent safety and quality requirement, it requires significant input in terms of design engineering skills manufacturing and fabrication skills welding skills post welding heat treatment skills
11. INDEPENDENT MARKET RESEARCH REPORT (Cont’d) o VITAL FACTOR CONSULTING Creating Winning Business Solutions research and development tedmical knowledge. These technical skill sets represent some barriers to entry. • The design, engineering and manufacturing skills are more demanding in the manufacturing of larger Process Equipment, such as column, pressure vessels and LPG mOWlded bullets, as the complexity increases due to the thicker material used, larger welding surface area, different welding strength, and the sheer size of the equipment in terms of fabrication, handling, lifting and transportation.
• In the manufacture of certain large Process Equipment such as LPG mOWlded bullets or pressure vessels, steel with thickness of up to 100nun are used. Thus, the manufacturer must have the appropriate machine and skills to bend steel plates ofsuch thickness. The facilities and skills required in the manufacturing of large Process Equipment fonn another barrier to entry into the industry.
• In addition to design, engineering and manufacturing skills, some customers may specify that the Process Equipment are to be manufactured to international recognised codes such as those set by the ASME, National Board or TUV of Germany. In this respect, only manufacturers that have received accreditation and approval from such bodies are authorised to use the internationally recognised stamps or mark on the equipment.
• The buyers of Process Equipment are essentially international oil companies and Engineering Procurement Construction Contractors (EPee). As such, the manufacturers, in bidding for a job, must have excellent safety records and attained recognised quality management system such as ISO 9001 and ISO 9002.
• It is connnon in the industry for vendors and suppliers to be pre-qualified or pre­approved as authorised vendors or suppliers before they are allowed to bid for jobs.
• The above requirements and accreditations fonn some barriers to entry for new entrants.

5. Supply -Production • As detailed data for the production of Process Equipment for the Oil, Gas and Petrochemical Industries is Wlavailable, the following general information is used to provide some indication of the production ofthe industry. Manufacture of Structural Metal Products • Between 1998 and 2002, the sales value of Structural Metal Products recorded an average annual growth rate ofapproximate1y 3.1%.
• However, in 2002, the sales value of Structural Metal Products decreased by 4.9% to approximately RM 1.2 billion (based on 30 establishments with more than 30 employees).

(Source: Monthly Manufacturing Statistics December 2002. Department of Statistics)
11. INDEPENDENT MARKET RESEARCH REPORT (Cont’d) o VITAL FACTOR CONSULTING Creating Winning Business Solutions Manufacture of Boilers, Heaters, Sterilisers, Pressure Vessels • Between 1997 and 2001, the sales value of Boilers, Heaters, Sterilisers and Pressure Vessels decreased at an average annual rate of7.5%.
• For the fust seven months of 2002, sales value of Boilers, Heaters, Sterilisers and Pressure Vessels increased by 7.9% compared to the same period in 2001.
• Between 1997 and 2001, the production quantity of Boilers, Heaters, Sterilisers and Pressure Vessels declined at average annual rate of 17.4%.
• However, for the first seven months of 2002, production quantity of Boilers, Heaters, Steriliser and Pressure Vessels almost doubled compared to the same period in 2001.

(Source: Department ofStatistics) Manufacture of Storage Tanks • Between 1997 and 2001, the sales value of Storage Tanks declined by an average annual rate of 1.9%.
• For the first seven months of 2002, the sales value of Storage Tanks decreased by approximately 27.0% compared to the same period for 2001.
• Between 1997 and 2001, the production quantity of Storage Tanks declined by average rate of8.5% annually.
• However, for the first seven months of 2002, the production quantity of Storage Tanks registered a growth of24.8% compared to the same period for 2001.

(Source: Department ofStatistics) 6. Imports of Process Equipment • In 2002, import value of steam or other vapour generating boilers superheated water boilers, and auxiliary plant for use therewith, decreased by 79.1% amounting to RM158.8 million (There is a high fluctuation in import value from year to year for this item, where import values for 2000 and 2001 were RM120.0 million and RM761.4 million respectively) (Source: Monthly External Trade Statistics December 2002. Department ofStatistics).
• Process Equipment, among others, is incorporated in various categories within the overall Machinery and Equipment Industry, and the import perfonnances of these categories are as follows:

Average Annual Growth Rate 1997 to 2001 (%)  Growth Rate 2001 (%)  Import Value 2001 (RM billion)  Power Generating Machinery and EauiDment  10.3  25.9  6.8  Machinery and Equipment for Specific Industries  -5.9  -32.0  8.7  Metal Working Machinery and Eauioment  -6.7  -15.2  2.8

11. INDEPENDENT MARKET RESEARCH REPORT (Cont’d) o VITAL FACTOR CONSULTING Creating Winning Business Solutions • In 200 I, the import value of containers for compressed or liquefied natural gas of iron/steel increased by 42.5% and amOlmted to approximately RM63.0 million.
• In 2001, import value of tanks, and similar containers of iron/steel of capacity exceeding 300 litres increased by 46.0% amounting to RM55.9 million.

(Source: Malaysia International Trade and Industry Report 2001, Ministry of International Trade and Industry Malaysia) 7. Demand and Demand Dependencies • Demand for Process Equipment for the Oil, Gas and Petrochemical Industries will come from local and overseas customers. Performance of Exports of Process Equipment • Process Equipment, among others, is incorporated in various categories within the overall Machinery and Equipment Industry, and the export performances of these categories are as follows:
• In 2001, the export value of containers for compressed or liquefied natural gas of iron/steel decreased by approximately 25.0% and amounted to approximately RM49.2 million.

Average Annual Growth Rate 1997 to 2001 (%)  Growth Rate 2001 (%)  Export Value 2001 (RM billion)  Power Generating Machinery and Equipment  11.6  -5.4  2.8  Machinery and Equipment for Snecific Industries  15.9  7.3  2.7  Metal Working Machinery and Equinment  6.5  -8.9  0.4
• In 2001, export value of tanks, and similar containers of iron/steel of capacity exceeding 300 litres increased by 35.2% amounting to RM67.6 million. (Source: Malaysia International Trade and Industry Report 2001, Ministry of International Trade and Industry Malaysia) Performance of User Industries -Production • The performance of user industries, that is, the Oil, Gas and Petrochemical and dmvnstream Industries will also have a direct impact on the demand for Process Equipment. The following presents an assessment of the perfonnance of the various user industries. • In 2002, sales value of production of Crude Oil Refineries increased by 4.0% compared to 2001 (Source: Monthly Manufacturing Statistics December 2002, Department ofStatistics Malaysia).
11. INDEPENDENT MARKET RESEARCH REPORT (Cont’d) o VITAL FACTOR CONSULTING Creating Winning Business Solutions • In 2002, production of natural gas registered an estimated growth of 6.3% to 4,864 million standard cubic feet per day (nunscfd) following increased domestic corummption ofnatural gas. (Source: Economic Report 200212003. Ministry ofFinance).
• Between 1998 and 2002, production quantity of Liquefied Petrolemn Gas grew at an average annual rate of 20.2%. In 2002, production increased by 27.6% to reach 2.9 million tOMes.
• Between 1998 and 2002, the sales value of crude oil refmeries increased at an average annual rate of 29.7%. In 2002, sales value increased by 4.0% amounting to RM22.7 billion.
• Between 1998 and 2002, production volmne ofGasoline grew at an average annual rate of2.4%. In 2002, production decreased by 2.4% to 2.6 million toMes.
• Between 1998 and 2002, production volume of DieselfGas Oil increased at an average annual rate of 12.2%.. In 2002, production declined by 1.8% amounting to approximately 9.5 million tOMes.
• Between 1998 and 2002, production quantity of Liquefied Petrolemn Gas grew at an average aMual rate of 20.2%. In 2002, production increased by 27.6% amounting to
2.9 million tonnes.
• Between 1998 and 2002, sales value ofIndustrial Gases grew at an average annual rate of 14.9%. In 2002, sales value registered a negative growth of approximately 6.7% amoWlting to RMI3.0 billion.
• Between 1998 and 2002, sales value of Synthetic Resins, Plastic Materials and Man· made Fibre except Glass grew at an average aMual rate of 13.2%. In 2002, sales value grew by 9.6% amounting to RM5.8 billion (based on 30 establislunents with more than 30 employees).

(Source: Monthly Manufacturing Statistics December 2002, Department of Statistics Malaysia) Performance of User Industries -Exports • In 2001, earnings from crude oil exports declined by 21.9% to RMll.1 billion. This is due to the lower export volume and sharp declined in Malaysia’s crude oil price to a weighted average ofUS$24.88 per barrel from U8$29.89 per barrel in 2000.
• However, for the eleven months of 2002, the gross export value of crude oil increased by 1.0% to reach RMlO.5 billion cotr{lared to the same period in 2001.
• In 2001, the export volume of crude oil declined by 9.6% to reach 15.1 million tOMes. However, for the first eleven months of 2002, export volume of crude oil increased by
8.1 % to reach 14.9 million tOMes compared to the same period in 200 I.
• In 2001, export volume of LNG increased marginally by 0.4% to reach 15.5 million tonnes. With a decrease in price, earnings from liquefied natural gas (LNG) exports also declined by 0.7% to RM 11.3 billion.

11. INDEPENDENT MARKET RESEARCH REPORT (Cont’d) o VITAL FACTOR CONSULTING Creating Winning Business Solutions • In 2001, the export value of petroleum products increased by 3.4% amounting to RM8.4 billion. Between 1997 and 2001, export value of petroleum products increased at an average annual rate of25.7%. (Source: Monthly Statistical Bulletin December 2002, Bank Negara Malaysia) Implications • The overall strong performance of user industries in Oil, Gas and Petrochemicals, as well as downstream industries, will continue to sustain and provide growth for operators within the Process Equipment for the Oil, Gas and Petrochemical Industries. 8. Production Dependencies • The major raw materials required for the manufacture of process equipment include
the following: hot rolled steel plates steel and iron materials dish head paints and coatings pipes and fittings rube bundles.

• Other minor raw materials include: welding materials (electrodes, wire and flux) tube sheets studs, bolts, nuts and washers electrical and wiring electrical heating bundles insulation materials nozzles and flanges.

• Within KNM Group, steel plates and other iron and steel materials accounted for approximately 60% of total raw materials used in the manufacturing of process equipment (Source: KNM Group)
• Within KNM Group, imports account for approximately 80% of the total raw materials used for the manufacturing of process equipment (Source: KNM Group).
• Some of the main reasons for using imported raw materials are as follows:

Operators including KNM Group are sometimes required by the customers to source from approved manufacturers which are overseas; Customers’ specified grades of materials are not locally manufactured. • Although some of the raw materials may be available locally, these are mainly for general industrial use and are not suited for specialised applications in the manufacturing of Process Equipment for the Oil, Gas and Petrochemical Industries. 11. INDEPENDENT MARKET RESEARCH REPORT (Cont’d) o VITAL FACTOR CONSULTING Creating Winning Business Solutions • Under these circumstances, the Malaysian Industrial Development Authority will review each case and provide duty and tax exemptions on the import of raw materials for the manufacturing of Process Equipment. Thus far, the Malaysian Industrial Development Authority has approved KNM Group’s request for duty and sales tax exemption for the import of its raw materials. Supply of Hot-Rolled Steel Plates • Currently only Jikang Dimensi SOO Bhd manufactures steel plates and in 2001, it produced 11,000 tonnes ofsteel plates. (Source: Status and Outlook of the Malaysian Iron and Steel Industry 2001, Malaysian Iron and Steel Industry Federation) • Between 1997 and 2001, the import value of hot-rolled steel plate (flat-rolled products of iron or non-alloy steel, of width of 600mm or more, hot-rolled, not clad, plated or coated, not in coils, of a thickness exceeding 10mm) decreased at an average annual rate of 15.9%. In 2001, import value declined by 11.2% amounted to RM154.7 million.
• Between 1997 and 2001, import volume of hot rolled steel plate (flat-rolled products of iron or non-aHoy steel, of width of 600mm or more, hot-rolled, not clad, plated or coated, not in coils of a thickness exceeding 10mm) declined at an average annual rate of 18.7%. In 2001, the import volume declined by 5.6% to reach 143,855 tOMes.
• In 2001, the top four countries of import representing 72% of total imports under this

type of category were: Ukraine Japan India United States of America.
(Source: Department ofStatistics) Supply of Other Iron and Steel Material • Other Iron and Steel Material include materials such as angles, beams, channels, round bars, flat bars, wires and wire mesh. However angles and beams would represent the majority of the iron and steel materials used in the manufacturing of process equipment.
• A high proportion of iron and steel materials still have to be imported, particularly the higher grade materials as these are not available locally.

• There are currently 51 producers of bars/wire rods/sections, and 40 producers of wire mesh in Malaysia (Source: Industry Brief on Iron and Steel Industry, Malaysian Industrial Development Authority, February 2001). • According to the Malaysian Iron and Steel Industry Federation, the production ofbars is especially well catered for in Malaysia. The major producers of bars and wire rods in Malaysia are Perwaja Steel, Amsteel Corporation, Southern Steel, Malayav.rata, Antara Steel and Malaysian Steel Works. The numerous producers of wire and wire products are mostly small-scale producers (Source: Report on Status and Outlook of the [ron and Steel Industry 2001. Malaysian [ron and Steel Industry Federation). 11. INDEPENDENT MARKET RESEARCH REPORT (Cont’d) o VITAL FACTOR CONSULTING Creating Winning Business Solutions Supply of Tubes and Tube Sheets • Tubes and tube sheets are part of the components of heat exchangers, one of the process equipment manufactured. These are 100% imported because specialised grade of tubes and tube sheets are not produced in Malaysia. (Source: Report on Status and Outlook of the Malaysian Iron and Steel Industry 2001, Malaysian Iron and Steel Industry Federation).
Supply of Dish Head
• Dish heads are parts of a pressure vessel that are used to close off the ends of the vessel shell. As all the raw materials for the dish head have to be compatible and equivalent to the rest of the pressure vessel, which are formed using hot-rolled steel plates, this material is predominantly imported.

9. Competitive Nature ofthe Industry • All manufacturers ofProcess Equipment operate under normal competitive conditions.
• Competition comes in 2 forms: Local production

 

Import<. • There is no undue monopolistic pressure either from the sourcing of raw materials or in the sales ofproducts.
• As with most free enterprise environments, competition is based on a number of factors,

including: cost compliance to technical specifications quality service. Competitive Intensity • Competitive intensity amongst the manufacturers of Process Equipment for the Oil, Gas and Petrochemical Industries is low to moderate and will depend on the types of projects as follows: Competitive intensity for small and mediwn-sized projects are moderate as there are between thirty to fifty manufacturers for this category ofprojects; Competitive intensity for mega-sized projects are low as there are less than ten manufacturers for this category ofprojects; Competitive intensity for projects requiring design and engineering capabilities are low as there are relatively few manufacturers with in-house design and engineering skills. (Source: Primary Market Research undertaken by Vital Factor Consulting) • Competitive intensity is mainly predicated by the barriers to entry, which differs across different types ofprojects. These barriers include, among others, the following: Availability oftechnical skill sets and competency; 11. INDEPENDENT MARKET RESEARCH REPORT (Cont’d) o VITAL FACTOR CONSULTING Creating Winning Business Solutions Ability to meet the requirements for accreditation to various intt:mational bodies, and conl>liance 10 various manufacturing codes: Availability of machines, facilities and skilled operators, especially for mega· sized projects; Satisfied pre-qualification by customers; Preference for local manufacturers.
10. Key Players in the Industry • Some ofthe major loul manuractu.rers are as follows: KNM Process System Sdn BM (fonnerly known as KNM Steel Sdn Bhd) Dialog Group Berhad Tepat Teknik Sdn Bhd Petra Perdana Berhad Amalgamated Metal Corporation Sdn Bbd CN Asia Corporation Bemad Torsco Berhad CBI (M) Sdn Bhd Enco Systems Sdn Bbd Ikatan Engineering Sdn Bbd Kejuruteraan QKS Sdn Bild MKE Engineering Sdn Bhd (formerly knO’Nl1 as Mechmar Keppel Engineering SdnBhd) Malaysia Shipyard & Engineering Sdn Bhd. • It should be noted that some of the local key manufacturers mentioned also undertake other activities outside of the manufacturing of Process Equipment for the Oil, Gas and Petrochemical Industries.
• Some of the foreign manufacturers opernting outside of Malaysia include the

following: Hyundai Heavy Industries Co. Ltd, South Korea Sumitomo Heavy Industries Ltd, Japan lshika\.\’iIjima Uarima Heavy Industries Co. Ltd. Japan Kvaemer Process System Pty Ltd, Australia Escher Holand BV, Netherlands Mid-Continent Equipment Pte Ltd, Singapore W.E. Smith Hudson Ply Ltd, Australia SIF Group BV, N~therlands Edmonton Exchanger Group, United States ofAmerica. (Source: Primary Market Research undertaken by Vital Factor Consulting) 11. Industry Outlook and Growth Forctast • The oUllook of the Process Equipment for Oil, Gas and Petrochemical Industries is favourable.
• The Industry is expected to grow at approximately S% to 7% per annum for the next five years.

11. INDEPENDENT MARKET RESEARCH REPORT (Cont’d) o VITAL FACTOR CONSULTING Creating Winning Business Solutions • The forecast is based on the assumption of a stabilised world economy and Malaysian economy and it does not take into consideration the impending threat or outbreak of war.
• The current uncertainty in the United States and the world economy may impact on the growth of Process Equipment Industry in the short tenn, however it is expected that growth will revert to nonnal in the medium to long tenn.
• The outlook and growth forecast is based on the following observations and analysis of the Process Equipment Industry.

5-year Growth Trends Between 1998 and 2002, sales value of the Manufacture of Structural Metal Products grew at an average annual rate of 3.1% amounting to approximately RMl.2 billion (Source: Monthly Manufacturing Statistics December 2002, Department of Statistics); Between 1997 and 2001, the production quantity of Boilers, Heaters, Sterilisers and Pressure Vessels grew at an average annual rate of 7.5% amounting to approximately RM106.0 million (Source: Department ofStatistics). Recent Growth Trends Growth Rate for first Seven months in 2002 compared to same Period in 2001  Production quantity of Boilers, Heaters, Sterilisers and Pressure Vessels  123.4%  Sales value of Boilers, Heaters, Sterilisers and Pressure Vessels  7.6%  Production quantity ofStorage Tank  24.8%  Sales value of Storage Tanks  -27.0%  Manufacture of Structural Metal Products  -4.9%
Source: Monthly Manufacturing Statistics December 2002, Department of Statistics • The growth of the Industry is highly dependent on the performance of the Oil, Gas and Petrochemical Industries. Hence the outlook and growth forecast is also based on the following observations and analyses of the local Oil, Gas and Petrochemical Industries: 11. INDEPENDENT MARKET RESEARCH REPORT (Cont’d) o VITAL FACTOR CONSULTING Creating Winning Business Solutions 5·Year and Recent Growth Trends Sales value of Crude Oil Refineries  Growth Rate 1998 to 2002  Growth Rate 2002  Amount In 2002  29.7%  4.0%  RM 22.7 billion  Production quantity of Gasoline  2.4%  -2.4%  2.6 million tonnes  Production quantity of LPG  20.2%  27.6%  2.9 million tonnes  Production quantity of Diesel Oil  12.2%  ·1.8%  9.5 million tonne  Sales value of Industrial Gases  14.9%  -6.7%  RM13.0 billion  Sales value of Manufacture of Synthetic Resins, Plastic Materials and Man-made Fibre except Glass  13.2%  9.6%  RM5.8 billion*
*based on 30 establIshments with more than 30 employees Source: Monthly Manufacturing Statistics December 2002. Department ofStatistics Despite some decrease in 2002, the 5-year trend between 1998 and 2002 of the local production of the Oil, Gas and Petrochemical Industries showed strong growth. • The growth of the Process Equipment Industry is also dependent on the export performance of the Oil, Gas and Petrochemical Industries. 5-Year Growth Trends Growth Rate 1997 to 2001  Amount In 2002  Export value of Petroleum Products  25.7%  RM8.4 billion  Gross export value of Chemicals and Chemical Products  16.3%  RM14.9 billion  Gross export value of Crude Oil  12.0%  RMl1.1 billion  Gross export value of Liquefied Natural Gas  15.0%  RMI1.3 billion  Gross export of Crude Oil  -9.6%  15.1 million tonnes  Gross export volume of Liquefied Natural Gas  0.4%  15.5 million tonnes
Source: Monthly Statistical Bulletin December 2002, Bank Negara Malaysia Despite the local and global economic slowdown in 2001, the 5-year trend between 1997 and 200 I is generally positive. 11. INDEPENDENT MARKET RESEARCH REPORT (Cont’d) o VITAL FACTOR CONSULTING Creating Winning Business Solutions 12. Threats and Risks Analysis Overseas Competition and Implementation of Asean Free Trade Area (AFTA) • The Industry faces competition from overseas, especially internationally recognised manufacturers of Process Equipment.
• Additionally, as AFTA becomes fully implemented from 2003, the import duties of Process Equipment wiJl be reduced to between 0% and 5% for Asean (Association of South East Asian Nations) manufacturers that comply with local content requirements. The reduction of import duties with the implementation of AFfA would encourage imports from Asean countries, thus creating further competition.

Mitigating Factors • Local players have some advantage over overseas players as they are familiar with the local environment and business culture. This is particular important because jobs lUldertaken require constant interaction with clients.
• Local players may be more price competitive due to the use of local workers and raw materials where available. Geographically, local players have the advantage of being able to mobilise staff, equipment and materials quickly and cheaply. Additionally, local production would minimise cost of transportation compared to process equipment manufactured overseas.
• In addition, Malaysia has been subjected to the Asean CEPT since its inception in 1995 and the rates are generally at 0% to 5% as follows.

Products  Import Duties {%l  ASEAN*CEPT (%)  Heat Excha~er Unit: CoolinQ: Towers  25  0  Steam or Other Vannur Generatin~ Boilers  10 20  5  Pressure VesselsA  30  5
… Common Effective PreferentIal Tariff APressure Vessels is categorised under ‘Others’ which includes machinery, plant or laboratory equipment, whether or not electrically heated, for the treatment ofmaterials by a process involving a change oftemperature. Source: Malaysian Tariff200J, Royal Customs and Excise Thus, any further reduction with the introduction of AFTA would be minimal. However, any imports outside of the Asean cOlUltries would continue to attract import tax at the rate indicated above. Implication • KNM Group is well aware of the threats from other overseas suppliers. Due to KNM Group’s designing and engineering skills, with the ability to offer quality products and services through research and development combined with competitive pricing have enabled KNM Group to win jobs from Petronas and other oil companies in an industry previously dominated by international manufacturers from Korea, Japan and Europe. 211 11. INDEPENDENT MARKET RESEARCH REPORT (Cont’d) o VITAL FACTOR CONSULTING Creating Winning Business Solutions Global Oil Price Fluctuations • Crude Oil and Gas is a commodity that is subjected to international long-term and spot prices. In addition, price and production pressures from cartels, for example Organisation of Petroleum Exporting Countries (OPEC) will have significant impact on the Oil and Gas Industries.
• Thus, an extended poor Oil and Gas prices may discourage exploration. Alternatively, an extended high Oil and Gas prices may reduce demand for Oil, Gas and Petrochemical products. These two situations have a direct impact on the demand for processing equipment.
Mitigating Factors
• Oil, Gas and Petrochemical products are essential raw materials for a whole host of applications ranging from transportation and energy requirements to consumer and industrial products.
• For the demand of Process Equipment to be affected, an extended period of abnormal price increases or decreases would have to take place.
• Even under an extended price increase or decrease, the impact would not be overly severe as many of the Oil, Gas and Petrochemical products are essential raw materials for a large variety ofconsumer and industrial manufactured goods.
• Under an extended price increase or decrease, many industries will be affected. As such, the manufacture of Process Equipment is likely to follow the overall economic trend and would not necessary be singled out to suffer the most impact.

Alternatives to Oil and Gas • Oil and Gas are both non-renewable resources. They are also contributors to pollution and the cause of the ‘greenhouse’ effect especially in major cities in the world.
• As such, there are significant moves to fmd alternative supply of energy, especially
those that are non-polluting and renewable. Some of these include: nuclear energy wind hydropower waves natural thermal energy solar
• The success of these alternative energies would reduce the demand for Oil and Gas. This will directly impact on the demand for Process Equipment in these industries.
Mitigating Factors
• The search and development of alternative energy sources has been going on for more than twenty years. To date, the use of Oil and Gas continues to dominate in all industries and our everyday lives.
• lt is not foreseeable that Oil and Gas will be significantly replaced by alternative energy sources within the immediate and medium term.

11. INDEPENDENT MARKET RESEARCH REPORT (Cont’d) o VITAL FACTOR CONSULTING Creating Winning Business Solutions • In addition, regardless of developments in alternative energy sources, industries today throughout the world have grown highly dependent on Petrochemical products.
Implications
• The high and continuing dependency of Oil, Gas and Petrochemical products locally and globally will continue to sustain and provide growth opportunities for manufacturers of Process Equipment focusing on these industries.
• Malaysia is a manufacturing-based economy. As such, the continuing use ofOil, Gas and Petrochemical products in the manufacturing sector will continue to sustain and provide growth opportunities for manufacturers of Process Equipment.
Exchange Rate Fluctuations
• The Industry is subjected to fluctuations in foreign exchange in terms of import of raw materials as well as undertaking business overseas.
Mitigating Factor
• The pegging of the Ringgit to the US Dollar has successfully stabilised the exchange rate. However, the situation may change.
Implication
• It is common within the industry for manufacturers to charge the total cost of raw materials directly to the customer. This is especially the case for KNM Group. As such, exposure to foreign exchange fluctuations is conunonly borne by the customer prior to the acceptance of the order.

Fluctuations in the Prices of Raw Materials • The Industry is subjected to fluctuations in prices of raw materials especially steel and this may have an impact on the profit margin of manufacturers. Hot-rolled steel plates accOlUlts for approximately 40% of the total raw materials used in the manufacturing of Process Equipment for KNM Group. Prices of steel have been known to increase two to three times of its original price.
Mitigating Factor
• Any increases in the prices of raw materials including steel can he passed onto the customer. This is a nonnal practice within the industry. In such situations, quotations submitted are subjected to revisions if there are changes in the prices of raw materials.
Implication
• Manufacturers are therefore protected to a certain extent, from price increases in raw materials including steel. Thus far, KNM Group has experienced increases in steel prices but this has not impacted negatively on its business.

11. INDEPENDENT MARKET RESEARCH REPORT (Cont’d) o VITAL FACTOR CONSULTING Creating Winning Business Solutions 13. DRIVERS OF GROWTH • The main drivers of growth for the Manufacturing of Process Equipment for the Oil, Gas and Petrochemical Industries is depended on three categories of manufacturers and users: Producers and manufacturers ofOil and Gas products; Intermediate users of Oil and Gas products for the manufacture of Petrochemical and Industrial Gas products; End-user of Oil, Gas and Petrochemical products including industrial and consumer end-users. • The ultimate driver of growth is dependent on consumption or end-user demand for Oil, Gas and Petrochemical products. This is largely influenced by the following factors: Local Market Increased demand for crude oil and natural gas driven by increased in transportation and energy requirements as a result of the improvement in the Malaysian economy; Increased activities in the manufacturing sector driven by the strong growth in usage of petrochemical products including various types of plastic and plastic products, synthetic fibre, synthetic rubber products, industrial gases and organic chemicals. Overseas Markets Increased in demand for crude oil and natural gas driven by improvement in the performances of global economies; Increased in exports of Petrochemical products for the manufacturing sector; Increased in export of manufactured products that use Petrochemical products. Local and Overseas Markets Increase in the application of natural gas as it is regarded cleaner and ‘greener’ to the environment in light of the ‘greenhouse effect’. This will augur well for Malaysia as its reserves of natural gas is expected to last for another 30 to 45 years; Increase in consumer affluence that in tum increases economic activities including manufacturing, transportation and energy requirements. • Drivers of growth will also be dependent on the continuing exploration and production activities of Oil and Gas companies to ensure future and long-term supply. 11. INDEPENDENT MARKET RESEARCH REPORT (Cont’d) o VITAL FACTOR CONSULTING Creating Winning Business Solutions 14. AREAS OF GROWTH AND OPPORTUNITIES Vertical Integration • The manufacture of Process Equipment in Malaysia is fairly developed especially in dO\VII.stream activities. However, the upstream activities such as providing EPCC services and manufacturing of flat steel plates and parts for the Process Equipment are still underdeveloped.
• Most EPCe employed by Petronas and other oil companies are international EPeC companies.
• However, in tenns of business practicality, a local Process Equipment manufacturer with design and engineering skills, for example KNM, may undertake joint-venture arrangements with international EPCC to provide EPCC services. It is highly unlikely for a local Process Equipment manufacturer to become an EPCe. This is because an EPCC must O\VII. proprietary processes to design the entire Oil, Gas or Petrochemical processing plant.
• Thus, the opportunity in vertical integration is in joint-venture arrangements with established and international EPCe.

Horizontal Diversification -Exotic Metals • Opportunities in horizontal diversification mainly lie in the use ofexotic metals.
• Exotic metals are critical for Process Equipment that operates under harsh environment. These environments may include the processing and transportation of corrosive gases and chemicals, and applications ofvery high or low temperatures.
• Opportunities exist for local manufacturers 10 incorporate exotic metals because, to date, there are hardly any local manufacturers that are able to use exotic metals.

Horizontal Diversification -Providing Outsourcing Services • Skills and services developed within the Oil, Gas and Petrochemical Industries can be applied to other less stringent and demanding Process Equipment.
• These may include, among others, the following industries: Pulp and Paper Mills; Food and Beverages Processing; Oil Palm Mills and Refineries.

• Services that Manufacturers of Process Equipment for the Oil, Gas and Petrochemical Industries may provide to other less demanding manufacturing industries include the following:

Systems Design and Engineering; Time-of-Flight-Diffraction Non-Desnuctive Testing; International Procurement. 11. INDEPENDENT MARKET RESEARCH REPORT (Cont’d) o VITAL FACTOR CONSULTING Creating Winning Business Solutions 15. Market Ranking • Based on a production of 15,600 tOMes of steel used for the manufacture of Process Equipment in 2002, KNM Group ranked first in comparison to other local manufacturers of Process Equipment for the Oil, Gas and Petrochemical Industries in Malaysia.
• Based on a turnover of RM107.67 million in 2002, KNM Group ranked fourth compared to other local manufacturers of Process Equipment for the Oil, Gas and Petrochemical Industries in Malaysia.
• Companies selected for market ranking purposes do not exclusively manufacture Process Equipment for the Oil. Gas and Petrochemical Industries. Companies that were selected for comparison must at least undertake some manufacturing of Process Equipment for the Oil, Gas and Petrochemical Industries. In tenns of ranking by tonnage, the majority of the productions are for Process Equipment. In tenns of ranking by turnover, total turnover is used, which incorporates other activities that may not be related to Process Equipment for the Oil, Gas and Petrochemical Industries.

Vital Factor Consulting Sdn Bhd has prepared this report in an independent and objective manner and has taken all reasonable consideration and care to ensure the accuracy and completeness of the report. It is our opinion that the report represents a true and fair assessment of the industry within the limitations of, among others, secondary statistics and information, and primary market research. Our assessment is for the overall industry and may not necessarily reflect the individual performance of any company. We do not take any responsibilities for the decisions or actions of readers of this document. This report should not be taken as a recommendation to buy or not to buy the shares of any company. Yours sincerely
Wooi Tan Managing Director Vital Factor Consulting Sdn Bhd 216

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