We see downside risk to management’s FFB output growth guidance of 3-4% in FY20, given the 10.7% drop in FFB output in 1HFY20 and uncertainties arising from the closure of palm oil operations in Sabah. Manufacturing segment will likely see weaker performance ahead, mainly on the back of Covid-19 pandemic and sharply lower crude oil prices. We trim our FY20-22 core net profit forecasts by 4.2-4.7%, largely to account for lower profitability assumption at the downstream segment. Despite the downward revision in our core net profit forecasts, we reiterate our BUY rating on KLK, with a marginally higher TP of RM22.82 (from RM20.48 earlier), as we recalibrated our earnings model and updated our valuation parameters. Besides, we note that valuation remains commendable at current share price level despite recent share price recovery. At RM21.26, KLK is trading at P/B of 2.1x, close to its previous low in Aug-2015, when CPO prices ranged bound at around RM1,800-2,100/mt).

Downside to FFB output growth guidance of 3-4% in FY20. Despite an 10.7% decline in FFB output (in 1HFY20) and the closure of palm oil operations in 6 districts of Sabah state, management is still keeping to its FFB output growth guidance of 3-4% in FY20, as it is hopeful that crop will start picking up from Mar-20 onwards. We think it may be difficult to attain such FFB output growth as 1HFY20 FFB output of 1.87m mt only accounts for 44% of its FY20 guided FFB output (assuming FFB output growth of 3%), vs. 47-54% of the full-year output in the past 7 years (see Figure #1). This also indicates that FFB output growth would have to accelerate to 17% for the remaining months of FY20. Besides, the closure of palm oil operations in Sabah (if extended further) will drag KLK’s output further (as Sabah accounts for ~17% of its total planted area or ~20% of KLK’s total FFB output).

CPO production cost. Given our expectation of a lower FFB output in FY20, we project CPO production cost to inch up marginally (by ~3%) to ~RM1,500/mt (from RM1,456/mt in FY19), which is higher than management’s CPO production cost guidance of ~RM1,400/mt).

Manufacturing segment – tougher times ahead. Manufacturing segment will likely see weaker performance ahead, mainly on the back of Covid-19 pandemic and sharply lower crude oil prices, which will in turn affect demand and prices for downstream products.

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 FY20-22 core net profit forecasts by 4.2-4.7%, largely to reflect lower profitability assumption at the downstream segment (given our less positive view on the segment’s prospects). Our core net profit forecasts are based on average CPO price assumptions of RM2,350/mt for FY20 and RM2,400/mt for FY21-22.

Maintain BUY, with higher TP of RM22.82. Despite the downward revision in our core net profit forecasts, we reiterate our BUY rating on KLK, with marginally higher SOP derived TP of RM22.82 (from RM22.48 earlier), as we recalibrated our earnings model and updated our valuation parameters. Besides, we note that valuation remains commendable despite recent share price recovery. At RM21.26, KLK is trading at FY20 P/B of 2.1x, close to its previous low in Aug-2015 (see Figure #3 for historical P/B trend), when CPO prices ranged bound at around RM1,800-2,100/mt).

Source: Hong Leong Investment Bank Research - 8 Apr 2020