Investment Highlights

• Maintain HOLD on KL Kepong (KLK) with an unchanged fair value of RM25.70/share, which is based on a FY18F PE of 25x. KLK's 1HFY17 results exceeded our expectations but were within consensus estimates. We have raised KLK's FY17F earnings forecast by 4.4% to account for a higher-than-expected plantation EBIT margin.

• In the results announcement, KLK said that the performance of the plantation sector is expected to be better in FY17F compared with FY16. Forward sales of CPO are anticipated to partly compensate for lower CPO prices. KLK added that the expectation of a rise in production may affect CPO prices going forward as evidenced in the discounted prices for forward months. Although market conditions are challenging, the oleochemical division is envisaged to improve in 2HFY17 due to favourable raw material prices.

• KLK's core net profit (ex-forex changes and gain on disposal of land of RM491.6mil in 1HFY16) improved by 25.5% YoY to RM609.7mil in 1HFY17 as plantation earnings almost doubled. This helped offset a 56.4% decline in manufacturing (mainly oleochemical activities) EBIT. Manufacturing earnings fell in spite of a 37.2% YoY increase in revenue in 1HFY17, which was driven by higher selling prices and capacity expansions.

• EBIT margin of the manufacturing division shrank from 6.7% in 1HFY16 to 2.1% in 1HFY17 dragged by higher costs of stearin and palm kernel oil. Also, the division recorded smaller fair value gains on derivatives of RM4.1mil in 1HFY17 against RM23.6mil in 1HFY16.

• Comparing 2QFY17 against 1QFY17 however, manufacturing EBIT improved by 72.5% to RM67.2mil. EBIT margin edged up from 1.7% in 1QFY17 to 2.5% in 2QFY17. The rise in manufacturing earnings was underpinned by fair value gains on derivatives of RM33.2mil. Including realised gains, KLK's gains on derivatives amounted to RM49.3mil in total in 2QFY17. On a negative note, KLK said that oleochemical demand was weak towards the end of 2QFY17 as buyers are expecting further declines in selling prices.

• About 85% of KLK's fair value losses in derivatives in 1HFY17 were in respect of forward foreign exchange contracts while the balance 15% related to commodity futures contracts.

• KLK's FFB production climbed by 6.9% YoY in 1HFY17. Average CPO price realised surged by 37.4% from RM2,075/tonne in 1HFY16 to RM2,851/tonne in 1HFY17 while average palm kernel price climbed by 81.9% from RM1,578/tonne to RM2,871/tonne.

• Share of earnings in the Astra Agro/KLK refining joint venture in Dumai swung from a profit of RM5.8mil in 1HFY16 to a loss of RM8.7mil in 1HFY17 due to negative refining margins. KLK's share of losses in the unit widened to RM5.8mil in 2QFY17 from RM2.9mil in 1QFY17.

• KLK's balance sheet is healthy. Net gearing stood at 25.1% as at endMarch 2017 vs. 24.8% as at end-December 2016. About 70.5% of KLK's borrowings were in MYR while another 14.0% were denominated in USD

Source: AmInvest Research - 23 May 2017