Kuala Lumpur Kepong (KLK)’s 1H16 Core Net Profit* (CNP) of RM536m met expectations at 49% of both our and consensus forecasts. Interim dividend of 15.0 sen announced, within expectations. Earnings forecasts maintained, with an upgrade to OUTPERFORM (from MARKET PERFORM) and higher TP of RM26.17 (from RM25.25) as we roll forward our valuation base year to 1HCY17.

1H16 Within Expectations. 1H16 CNP at RM536m made up 49% of both our and consensus forecasts, with a 15.0 sen interim dividend announced, in line with previous years’ dividend trend.

Traditionally weak 2Q, but stronger 1H16 CNP. 2Q16 CNP declined 44% QoQ largely due to weaker FFB production, which fell 27% as seasonal low production was further impacted by last year’s drought. Core operating margins were weaker for both upstream (6.4%) and downstream (5.2%) segments, declining by 3.5% and 1.8%, respectively. YTD results, however, were much improved against 1H15, rising 41% on downstream margin recovery (+2.1% to 6.1%). FFB volume was also higher at +3%, partly offsetting lower CPO prices (- 4%).

Expect short-term upstream improvement. We expect the upstream Plantation segment to perform well in 3Q16, as quarter-to-date CPO prices averaged RM2,615/MT, 8% higher than RM2,415/MT recorded in 2Q16. However, management noted that ‘anticipated higher FFB production’ and ‘narrower discount of palm oil to soybean oil’ could limit palm oil price upside.

Stable downstream performance. Despite persistently soft crude oil prices, Manufacturing core margins (excluding derivative fair value changes) have stabilised at 5-7%. While management mentioned potential margin erosion, particularly for CPKO products due to rising feedstock prices, we believe segment margin should remain consistent due to incoming capacity expansions and efficiency improvements.

Maintain FY16-17E CNP at RM1.10-1.18b as 1H16 FFB growth and downstream margins remain in line with our forecasts.

Upgrade to OUTPERFORM with higher TP of RM26.17. We increase our TP to RM26.17 (from RM25.25) as we roll forward our valuation base year to 1HCY17 (from CY16) resulting in higher Fwd. EPS of 109.0 sen (previously 105.2 sen). Our Fwd. PER is maintained at 24.0x, implying mean valuation. We believe this is justified by KLK’s flattish FFB growth outlook of 3% (against the sector average of 6%). Nevertheless, we upgrade KLK to OUTPERFORM (from MARKET PERFORM) as we believe that its positive upstream outlook and stable downstream margins could draw interest from investors, especially with sustained strong CPO prices above RM2,500/MT since mid-March. 

Source: Kenanga Research - 17 May 2016