Investment Highlights

• We believe that KLK’s FY20F PE of 29.2x has already priced in improving prospects from the rise in CPO price. Hence, we are downgrading KL Kepong (KLK) to SELL from HOLD. Also, KLK’s share price is above our fair value of RM22.55/share. Our fair value for KLK is based on a FY20F PE of 27x.

• KLK’s core net profit (ex-FY19’s exceptional loss of RM54.1mil) is expected to strengthen by 32.6% in FY20F as increased upstream profits compensate for the softness in downstream earnings.

• We reckon that KLK’s upstream division would perform better in FY20F due to higher palm product prices. However, downstream (refining and oleochemical) earnings may decline in FY20F dragged by higher costs of feedstock (mainly palm products).

• Hence, there could be erosion in the EBIT margins of refining and oleochemical units in FY20F. KLK’s palm refining and kernel crushing activities are classified under the plantation division.

• According to the MPOB, average price of crude palm kernel oil (one of the feedstock for fatty acids) rose by 60.7% to RM3,758/tonne in December 2019 from RM2,338.50/tonne in October 2019.

• We forecast EBIT of KLK’s plantation division (including refining and palm kernel crushing) to improve by more than 50% in FY20F while manufacturing EBIT (mainly oleochemicals) is envisaged to decline by 15.6%.

• We have assumed a manufacturing EBIT margin of 4.0% in FY20F vs. 5.0% in FY19. There is risk that KLK may face a high cost of feedstock but at the same time, customers are delaying purchases as they wait for prices of raw materials to ease.

• As for the upstream division, we have assumed an FFB production growth of 0.3% for KLK in FY20F vs. 4.5% in FY19. KLK’s FFB output growth is not anticipated to be exciting in FY20F as the size of mature areas is expected to decline.

• KLK is envisaged to replant about 11,000ha to 14,000ha of ageing oil palm trees or 5% to 6% of planted areas in FY20F. Also, KLK’s oil palm trees in Indonesia faced stress in 4Q2019 as they were affected by the drought from July to September 2019. KLK’s FFB production fell by 11.5% YoY in 1QFY20.

Source: AmInvest Research - 20 Jan 2020