Investment Highlights

• Maintain SELL on Kuala Lumpur Kepong (KLK) with an unchanged fair value of RM22.65/share. Our fair value for KLK is based on a FY19F PE of 27x.

• We believe that KLK’s oleochemical division would continue to face challenging operating conditions in FY19F due to downward pressure on selling prices.

• We have assumed a manufacturing (mainly oleochemical activities) EBIT margin of 4.5% for FY19F, which is the same as FY18 (ex-impairment of RM21.6mil). We forecast KLK’s manufacturing core EBIT (ex-impairment) to improve by 5% to RM478.7mil in FY19F.

• There is stiff competition from Indonesia in the basic fatty acids segment. We believe that Indonesian companies are selling their products at competitive prices. The Indonesian oleochemical companies have two advantages over their Malaysian counterparts.

• First, the cost of raw material i.e. palm stearin or palm kernel oil is cheaper in Indonesia compared with Malaysia. This was especially prevalent when the domestic prices of palm products plunged in Indonesia in 2H2018 due to the glut in Kalimantan.

• Second, there is zero import duty on Indonesia’s oleochemical products in the European Union (EU) as the country is still under the GSP (Generalised System of Preferences) system.

• In contrast, as Malaysia was removed from the GSP list in 2014, the EU has imposed a 4% to 6% import duty on Malaysia’s oleochemical products. The mitigating factor is that KLK already has a presence in the EU. The group has a production capacity of about one million tonnes per year in the EU currently.

• As for the plantation division, we have assumed that KLK’s FFB production would improve by 4.7% in FY19F vs. 1.4% in FY18. The group’s FFB output growth was 6.5% YoY in 2MFY19.

• We believe that KLK’s production cost (ex-mill) would increase from RM1,370/tonne in FY18 to RM1,400/tonne in FY19F as costs of fertiliser and wages have risen.

• Fertiliser is expected to account for 35% of production costs while wages are envisaged to make up another 30% to 35%. Transportation is anticipated to account for the balance 30% to 35% of KLK’s CPO production costs.

Source: AmInvest Research - 23 Jan 2019