Investment Highlights

• We are keeping KL Kepong (KLK) as a HOLD with an unchanged fair value of RM25.50/share. Our fair value for KLK is based on an FY19F PE of 25x.

• KLK's 1HFY18 results were within our expectations but below consensus estimates. The group's net profit shrank by 41.0% from RM320.6mil in 1QFY18 to RM189.3mil in 2QFY18 as manufacturing earnings dropped by 18.5% and plantation profits declined by 31.9%.

• Comparing 1HFY18 against 1HFY17, KLK's net profit slipped 21.6% to RM509.9mil as plantation earnings were hit by lower selling prices and production. The division was also affected by net unrealised forex losses of RM65.4mil on loans advanced to Indonesian subsidiaries. Plantation accounted for 59.6% of group EBIT in 1HFY18.

• The QoQ decline in manufacturing EBIT in 2QFY18 was due to a fall in gross margins resulting from lower selling prices in China and Europe. KLK also recorded smaller fair value gains on derivatives of RM21.3mil in 2QFY18 compared with RM25.9mil in 1QFY18. EBIT margin of the manufacturing division slid from 6.1% in 1QFY18 to 4.7% in 2QFY18. Most of the derivatives gains of RM47.1mil in 1HFY18 (1HFY17: RM4.1mil) were in respect of forward foreign exchange contracts

• Plantation EBIT eased by 31.9% QoQ to RM184.4mil in 2QFY18 dragged by lower CPO price and production and losses in the processing and trading operations. Average CPO price was RM2,398/tonne in 2QFY18 vs. RM2,581/tonne in 1QFY18. Average palm kernel price was RM2,075/tonne in 2QFY18 against RM2,488/tonne in 1QFY18.

• KLK's FFB production contracted by 6.6% QoQ in 2QFY18 but rose by 1.5% YoY in 1HFY18.

• Share of net loss in the Astra Agro/KLK refining joint venture in Dumai widened from RM1.8mil in 1QFY18 to RM2.0mil in 2QFY18. KLK’s share of the net loss was smaller at RM3.7mil in 1HFY18 against RM8.7mil in 1HFY17. We attribute the refinery’s loss to untimely purchases of feedstock and declines in processing margins.

• In the results announcement, KLK said that CPO prices are expected to remain at current levels. Oleochemical operations may perform better than last year due to higher capacity utilisation and improved operational efficiencies. This is in spite of margin pressures resulting from increasing competition and foreign currency fluctuations. Overall, KLK expects a lower net profit for FY18F compared with FY17.

Source: AmInvest Research - 17 May 2018