Period  1Q15/3M15

Actual vs. Expectations  1Q15 core net profit* (CNP) of RM200m came in below expectations, making up only 18% of both our and consensus expectation of RM1.09b.

 This was due to lower-than-expected margin in its manufacturing division which declined YoY from 6% to 2%. Also, average realised CPO price at RM2,138/metric ton (MT) was 10% below CY14 average of RM2,384/MT.

Dividends  As expected, no dividend was announced.

Key Results Highlights  YoY, 1Q15 CNP declined 30% to RM200m due to weaker margins in its manufacturing division (EBIT declined 57% to RM35m), and lower earnings from plantations (EBIT dropped 6% to RM241m). The plantation division saw lower CPO prices (down 7% to RM2,138/MT) and lower FFB volume ( shrunk 5% to 955m MT).

 QoQ, 1Q15 CNP improved 17% to RM200m as manufacturing division recovered to RM35m from losses of RM5m. Plantation division EBIT improved 4% to RM241m on the back of higher revenue (+30% to RM1.80b). However, overall plantation segment margin declined QoQ from 17% to 13% due to higher production cost.

Outlook  Management highlighted that the current low crude oil prices have resulted in volatile fatty alcohol price due to increased competition from synthetic alcohol. We think the outlook for the manufacturing division will remain challenging going forward due to more capacity coming on-stream in the industry.

 For the plantation segment, we expect CPO prices to average RM2,200/MT in FY15 as we think CPO prices will weaken in 2H15 due to higher production, the weak Ringgit and low crude oil prices. Furthermore, we think the impact from lower CPO prices would only be partly mitigated by KLK’s expected 4% FFB growth (below the sector average of 7%).

Change to Forecasts  We trim our earnings forecast for FY15-16E by 5.4-1.0% to RM1.03-RM1.05b as we lower the oleochemicals division margin to 5.8-5.8% from 7.0-6.0%, assuming poorer margins from the fatty alcohols business, going forward.

Rating Downgrade to UNDERPERFORM  In light of the increasingly challenging downstream outlook and flattish plantation segment prospects, we downgrade KLK to UNDERPERFORM from MARKET PERFORM.

Valuation  We cut our TP to RM20.34 (from RM21.50 previously) based on an unchanged 21.0x Fwd. PER to lower FY15E EPS of RM0.97 (from RM1.27 previously). Our Fwd. PER of 21.0x implies the 3-year historical mean valuation. Note that most plantation counters are pegged to average valuation levels. As we are of the view that there are no near-term fresh catalysts for KLK that could trigger a higher valuation basis, we maintain mean valuation for KLK. Additionally, there are more potential earnings risks as the government has recently announced that CPO export duties will remain at 0% in Mar-15, which could continue to suppress margins in 2QFY15.

Risks to Our Call  Higher-than-expected CPO prices.  Better-than-expected margin for downstream division. 

Source: Kenanga