Period

1Q16/3M16

Kuala Lumpur Kepong (KLK)’s 1Q16 core net profit (CNP*) of RM344m exceeded both consensus (RM1.04b) and our expectation (RM0.97b) at 33% and 36%, respectively.

We believe this was due to stronger-than-expected margin recovery in the oleochemicals business (7.0% vs. 1Q15’s 4.3%, excluding derivative gains/losses).

Note that KLK’s 1Q16 Net Profit at RM795m includes one-off gains from plantation land disposal of RM486m.

Dividends

No dividend was announced, as expected.

However, in light of the one-off plantation land sale, we up our FY16E DPS to 80.0 sen (from 53.7 sen) reflecting higher Net Profit.

YoY, 1Q16 CNP rose 72% to RM344m driven by stronger Manufacturing EBIT (+282% to RM134m) as margins recovered to 7.0% (from 4.3%) on improved efficiency and higher derivative gains as mentioned. Plantation EBIT improved (+10% to RM266m) on higher FFB volume (+11% to 1.06m MT) which was partly offset by lower CPO prices (-8% to RM1,972/metric ton (MT)).

QoQ, 1Q16 CNP jumped 120% as Manufacturing EBIT tripled to RM134m on a reversal in derivatives losses. However, excluding derivative gains/losses, margin was maintained at 7.0%. Plantation EBIT was also higher (+40% to RM266m), also on derivatives losses reversal as well as slight improvement in CPO price (+1%) and FFB production (+1%).

Outlook

We expect the Plantation segment to perform well in the near term as quarter-to-date CPO prices averaged RM2,313/MT compared to the average of RM2,169/MT in FY15. However, KLK’s flattish FFB growth of 3% (vs. sector average of 6%) could limit upside. 

On the Manufacturing side, despite softer crude oil prices, margins appear to have stabilised above our expected 3-5% level. 

We expect the sale of plantation land to reduce FY16E gearing to 0.10x (previously 0.18x). Although plan for the proceeds is unknown, we reckon potential utilisation may include higher dividend payout or funding continued development of KLK's downstream businesses.

Upgrade FY16-17E CNP to RM1.10b-RM1.18b (+14-4%) as we update our Manufacturing segment margins as mentioned above.

Rating 

Maintain MARKET PERFORM call as the challenging downstream outlook and flattish FFB growth prospects may limit upside on the improving CPO prices.

Valuation

We increase our TP to RM25.25 (from RM22.80) based on unchanged 24.0x Fwd. PER applied to higher CY16E EPS of 105.2 sen (from 95.0 sen) post earnings upgrade. Our Fwd. PER is based on 3-year mean valuation basis which we think is justified by KLK’s flattish FFB growth outlook and stabilising Manufacturing segment margins.

Risks

Lower-than-expected CPO prices.

Lower-than-expected margin for its downstream division.