Kuala Lumpur Kepong - Unexciting Prospects

Date: 24/07/2018

Source  :  HLG
Stock  :  KLK       Price Target  :  23.95      |      Price Call  :  HOLD
        Last Price  :  21.50      |      Upside/Downside  :  +2.45 (11.40%)

KLK’s earnings growth prospects remain unexciting given current low CPO price environment, minimal near-term FFB output growth, impact from potential minimum wage hike and minimal near term contribution from property segment. On a slightly brighter note, we feel that weak prospects at upstream plantation and property segments will be partly mitigated by improved prospects at manufacturing segment, thanks to low CPKO price and improved demand. FY18-20 core net profit forecasts lowered by 0.9-1.7%, as we fine-tuned our FFB output and CPO production cost assumptions. Correspondingly, our SOP derived TP is lowered by 1.5% to RM23.95, with unchanged HOLD rating.

We walked away from our recent meeting with KLK’s management, feeling neutral about its earnings growth prospects.

FFB output growth to pick up from FY19. 9MFY18 FFB production growth slowed to 1.2% (at 2.91m tonnes) from 10.6% a year ago (see Figure #1). While FFB output will likely pick up more meaningfully in 4QFY18, management lowered its FFB output growth guidance in FY18 to ~3% from 5-6% previously, due to normalisation of output growth (post recovery from El Nino phenomenon) and more aggressive replanting activities (7,200 ha were replanted in FY17 and another 11,000 ha were earmarked for replanting in FY18). Moving to FY19, management shared that FFB output growth should pick up to 5-8%, mainly on the back of more areas moving into mature bracket.

Impact of minimum wage hike. While the quantum of minimum wage hike will likely remain unknown until next month, our estimates indicate that every RM100/month increase in minimum wage will impact our FY18-20 core net profit forecasts by 1.5- 1.6%, assuming all its labour in Malaysia operations (circa 15,000 labour, based on its FY17 annual report) will benefit from the potential minimum wage hike.

Impact of MFRS 116 and 141 adoption. We note that KLK will implement the new amendments to Malaysian Financial Reporting Standards (MFRS) 116 and 141 from Oct-19 onwards. While management has yet to disclose the impact of the new accounting standards to its earnings, our estimates indicate that the change in accounting standards will lower our FY18-20 net profit forecasts by circa 3%.

Better downstream prospects to partly mitigate weak near term upstream earnings. The manufacturing segment’s operating profit performance has been improving since Oct-17 (see Figure #2), and we believe performance at the manufacturing divisions will sustain in the near future (and partly mitigate weak near term upstream earnings prospects), underpinned by (i) low raw material prices (in particular, CPKO, the major raw material), and (ii) improved demand arising from rising crude oil prices (which has in turn boosted demand prospects of oleochemical products).

Property segment to remain quiet. We believe earnings contribution from property segment will remain quiet, on the back of weak property sentiment and delay in High Speed Rail (HSR) project (which may result in delay in property development plan in Gerbang Nusajaya, a joint development project between KLK and UEM Sunrise).

Forecast. We lower our FY18-20 net profit forecasts by 0.9-1.7%, as we fine-tuned our FFB output and CPO production cost assumptions. We have yet to reflect impact from (i) potential minimum wage hike, and (ii) adoption of MFRS 116 and 141 in our forecasts, pending further update from management.

Maintain HOLD with lower SOP-derived TP of RM23.95. Post downward core net profit forecast revision, we lower our SOP-derived TP on KLK by 1.5% to RM23.95.

Source: Hong Leong Investment Bank Research - 24 Jul 2018

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