Investment Highlights

• Maintain HOLD on Kuala Lumpur Kepong (KLK) with an unchanged fair value of RM27.50/share. Our fair value is based on an FY19F PE of 27x. In the past five years, KLK’s PE ranged from a low of 19.9x to a high of 28.5x. Average PE was 24.9x. We are keeping our FY18E net profit forecast for KLK. Our FY18E net profit forecast for KLK is 10.8% below consensus.

• We have assumed that KLK’s FFB production would inch up by 2.7% in FY18E vs. 10.8% in FY17. The group’s FFB rose by 1% in 11MFY18. We believe that KLK’s FFB output would be stronger in the final financial month of September 2018 compared with the negative YoY growth of 3% recorded in September 2017.

• Looking ahead to FY19F, we have assumed that KLK’s FFB output would expand by 4.0% underpinned by a 3% or 5,600ha increase in mature areas. Indonesia is expected to drive the increase in the group’s FFB production in FY19F. Indonesia accounts for about 51% of KLK’s annual FFB output. About 44% of KLK’s plantation landbank in Indonesia are located in Kalimantan while another 41% are in Sumatra. The balance 15% of KLK’s palm plantations in Indonesia are in Belitung.

• Barring any impairment or provision, we expect the EBIT margin of KLK’s oleochemical division to hover between 4.0% and 4.5% in 4QFY18 (3QFY18: 4.0%) on the back of a smaller fair value loss in foreign currency forward contracts and lower cost of RBD palm stearin.

• On the flip side, price of palm kernel oil (PKO) is rising. According to the MPOB, since June 2018, average monthly price of crude PKO in Peninsular Malaysia has climbed by 7.8% while price of RBD palm stearin for local delivery has fallen by 6.0%. PKO and palm stearin are the feedstock used to produce oleochemical products.

• We forecast KLK’s oleochemical EBIT to grow by only 7% in FY19F vs. 164.0% in FY18E. Going forward, we believe that operating conditions in the oleochemical industry would remain challenging. As KLK produces basic fatty acid products and not the high-margin specialised ones, the group faces more competition. The unit’s earnings rebound in FY18E comes after a slew of impairments and provisions in FY17.

• The intense competition has driven down prices of basic oleochemical products in the EU. In China, selling prices of oleochemical products have been weak due to competition from imports. Due to an unfavourable tax structure, it is cheaper to import oleochemical products instead of buying those produced locally. KLK has about 1mil tonnes of oleochemical production capacity in the EU and 0.45mil tonnes of capacity in China per year.

Source: AmInvest Research - 28 Sept 2018