Investment Highlights

• Maintain HOLD on KL Kepong (KLK) with an unchanged fair value of RM25.70/share, which is based on an FY18F PE of 25x. KLK is currently trading at FY18F PE of 24.5x and FY19F PE of 23.4x.

• At first glance, KLK's 1QFY18 results appear to be above our earnings forecast but within consensus estimates. In spite of this, we are keeping our FY18F earnings forecast to be conservative. We think that KLK's manufacturing EBIT margin would normalise to the usual 3% to 5% in the following quarters. 1Q is usually one of KLK's best performing quarters. Included in KLK's 1QFY18 results was a RM13.6mil gain from the government's compulsory acquisition of KLK's land.

• In its results announcement, KLK said that although its plantation earnings would be affected by the decline in CPO prices, this would be partly compensated by the oleochemical operations. The oleochemical unit has benefited from a higher capacity utilisation and operational efficiencies.

• KLK's net profit declined by 11.1% YoY to RM320.6mil in 1QFY18 as a 297% rise in manufacturing EBIT helped compensate for a 35.9% fall in plantation earnings.

• The plantation division was dragged by a 5.1% YoY decline in average CPO price and 1.9% YoY slide in FFB production in 1QFY18. Average CPO price realised was RM2,581/tonne in 1QFY18 vs. RM2,720/tonne in 1QFY17. Average palm kernel price shrank by 6% from RM2,648/tonne in 1QFY17 to RM2,488/tonne in 1QFY18. Comparing 1QFY18 against 4QFY17, KLK's FFB output improved by 2.5%.

• Manufacturing EBIT improved by 297% YoY to RM154.6mil in 1QFY18. EBIT margin of the manufacturing division was 6.1% in 1QFY18 against 1.7% in 1QFY17. Included in KLK's manufacturing EBIT in 1QFY18 were fair value gains of RM25.9mil on derivative financial instruments compared with fair value losses of RM29mil in 1QFY17. We believe that about most of the fair value gains in 1QFY18 were in respect of foreign exchange forward contracts.

• Apart from the fair value gains, the improvement in manufacturing margin was contributed by a lower raw material cost. KLK said that the cost of crude palm kernel oil had stabilised in 1QFY18. Also, the China operations had benefited from economies of scale of the new plant.

• Share of losses in the Astra Agro-KLK refining joint venture in Dumai declined from RM2.9mil in 1QFY17 to RM1.8mil in 1QFY18 due to fewer plant shutdowns and improvements in processing margins. KLK's share of losses in the refining unit in Dumai amounted to RM17.3mil in FY17.

• KLK's balance sheet is clean. Net gearing stood at 22.9% as at end-December 2017 vs. 20.7% as at end-September 2017. About 73.2% of KLK's borrowings were denominated in MYR while another 14.4% were denominated in USD as at end-December. An additional 12.4% of KLK's borrowings were denominated in EUR.

Source: AmInvest Research - 13 Feb 2018