We reiterate our less-than-positive view on KLK’s near term earnings outlook, mainly on the back of weak palm product prices and intense competition within the oleochemical sub-segment. Besides, we believe KLK may incur impairment on its investment in EPO, on the latter’s recently announced intention to cease its Butaw estate operations. We trim our FY19-21 core net profit forecasts by 6.2-7%, as we fine tune our FFB output and interest cost projections. Consequently, our SOP-derived TP is lowered by 2.4% to RM22.84. Maintain HOLD rating on KLK.

Following our recent conversation with management, we reiterate our less-than positive view on KLK’s near term earnings outlook, mainly on the back of weak palm product prices and intense competition within the oleochemical sub-segment.

FFB output growth insufficient to mitigate lower CPO prices. FFB output grew 4.9% to 3.05m tonnes in 9MFY19, and is on track to exceed 4m tonnes in FY19, thanks to more areas moving to mature bracket in its Indonesian estates. However, the decent FFB production growth is insufficient to mitigate the weak CPO prices and marginally higher production cost (arising from minimum wage hike in Malaysia and higher fertiliser prices).

Manufacturing division – tougher times ahead. After registering a decent 1HFY19, we believe KLK’s manufacturing division will see weaker performance in 2HFY19, mainly on the back of stiff competition, which has in turn resulted in weak oleochemical product prices.

May potentially write down its investment into EPO. We believe KLK may incur impairment on its investment in Equatorial Palm Oil (EPO), on the latter’s recently announced intention to cease its Butaw estate operations. EPO has to-date planted 1,418ha of oil palm plantation (out of a total concession area of 8,011ha) in Butaw estate. At this juncture, it remains unknown on the amount of the impairment (if it happens). We understand that KLK had a carrying value of circa RM110m on Butaw estate (as at 30 Sep 2018). Recall, KLK ventured into oil palm plantation business in Liberia via the acquisition of 62.9% stake in EPO and 50% stake in Liberian Palm Developments Ltd (of which EPO owns the remaining 50% stake) for US$21.3m in Nov-13.

Stable contribution from property development division. Despite weak property market sentiment, management still sees stable earnings contribution from its property development segment (albeit insignificant contribution relative to plantation and manufacturing divisions), by focusing on small-scale higher-end residential unit launches in Bandar Seri Coalfields.

Forecast. We trim our FY19-21 core net profit forecasts by 6.2%, 7.0% and 6.4% respectively, as we fine tune our FFB output and interest cost projections.

Maintain HOLD, TP: RM22.84. We maintain our HOLD rating on KLK, with a lower SOP-derived TP of RM22.84 (from RM23.39 earlier) following the downward revision in our core net earnings forecasts. Despite its steep valuations (at RM24.00, KLK is trading at FY19-20 P/E of 40.3x and 35x), we believe KLK will fare better relative to its peers in terms of share price resilience, given its (i) young age profile (12.1 years as at end FY18), and (ii) relatively sizeable contribution from downstream operations (which generates more stable earnings relative to upstream plantation business).

Source: Hong Leong Investment Bank Research - 18 Jul 2019