Investment Highlights

• Maintain HOLD on Kuala Lumpur Kepong (KLK) with an unchanged fair value of RM25.70/share. Our fair value is based on an FY18F PE of 25x. In the past five years, KLK's PE ranged from a low of 17.4x to a high of 23.5x. Average PE was 21.1x.

• Although FY18F is expected to be a cleaner year for KLK after impairments and provisions of RM123.8mil in FY17, KLK's core net profit is envisaged to decline by 2.6%. This is due to weaker plantation earnings resulting from a lower average CPO price. We have assumed an average CPO price assumption of RM2,650/tonne for FY18F vs. RM2,735/tonne recorded in FY17.

• Although our average CPO price assumption of RM2,650/tonne is higher than current spot prices of RM2,400/tonne to RM2,500/tonne, we are keeping our forecast for now as developments are extremely fluid in the plantation sector. We would be reviewing our CPO price assumption at the end of 2Q2018.

• KLK's manufacturing unit (mainly oleochemical activities) performed well in 1QFY18 on the back of fair value gains on derivatives of RM25.9mil, lower raw material cost and improving China operations. We believe that the fair value gains on derivatives came about as KLK managed to lock in a weaker MYR for its export proceeds while the MYR was appreciating against the USD. The manufacturing EBIT of RM154.6mil in 1QFY18 was the highest ever quarterly achievement.

• However, we believe that the fair value gains may not be sustainable going forward as the USD/MYR exchange rate has been more stable. In addition, we reckon that selling prices of oleochemical products would ease in line with the downward trend in feedstock costs. Price of crude palm kernel oil in the Central region has fallen by 42.5% from RM7,855/tonne in January 2017 to RM4,517.50/tonne in February 2018.

• We reckon that KLK's normalised manufacturing EBIT margin is between 4% and 5% compared with the 6.1% achieved in 1QFY18. We have assumed an EBIT margin of 5% for FY18F against 1.9% in FY17.

• As for the plantation division, we forecast KLK's FFB production to improve by 6.0% in FY18F vs. 10.8% recorded in FY17. Group production cost per tonne (exmill) is anticipated to be stable at RM1,400 in FY18F against RM1,389 in FY17. Fertiliser costs are expected to be flat in FY18F while wages in Indonesia are envisaged to increase by more than 8%.

Source: AmInvest Research - 28 Mar 2018