We recommend a “Trading Buy” on Kim Loong Resources Berhad (KMLOONG) with a fair value of RM3.66 based on a Target PER of 14.0x. The valuations are undemanding compared to small-cap plantation peers’ Fwd. PER of 20.6x, due to its: (i) earnings consistency driven by above-average yield per hectare (ha), (ii) long-term FFB growth supported by its maturing Sarawak acreage, (iii) strong balance sheet with FY17E net cash position of 60.5 sen with the above-average dividend yield of 4.6%, and (iv) expected FY17E earnings recovery of 10% on rising CPO prices.

Long-term earnings consistency. In FY16A, KMLOONG delivered FFB yield/ha of 21.7 metric tons (MT)/year, 24% higher than the small cap planters’ 2015 average of 17.5MT/year, and 17% higher than the 2015 Malaysian average of 18.5MT/year. We believe this justifies its higher enterprise value (EV)/mature ha of RM68.2k/ha or 34% above the small cap planters’ average of RM50.9k/ha. We believe KMLOONG’s consistent yield of above 21MT/ha and OER above 21% in the last 5 years contributed to its long-term earnings consistency, as we over the last 10 years, KMLOONG had seen positive earnings growth for 7 out of 10 years with the highest 10-year CAGR of 21% (average: 7%).

Aiming to grow in Sarawak. Management mentioned that they plan to expand their Sarawak operations via its 70-30 JV with the state government agency Pelita. We understand that the company has c.2.0k ha of plantable area in Sarawak out of its current 10.5k ha estates, and are also open to expanding their landbank in Sarawak, with preference for greenfield area. Management is also targeting a mill license in Sarawak within the next 1-2 years to support its young maturing estates, which have an average age profile of 6 years. We are positive on the continued development in Sarawak as the young acreage should contribute to positive FFB growth over the long-term.

Strong balance sheet supports above-average dividend yield. KMLOONG is in a solid net cash position with FY17E net cash/share of 60.5 sen vs. peers’ average net cash position of 15.4 sen. While we estimate the new mill capex to incur RM70m over FY18-19E, we still expect strong FY17-18E free cash flow of RM82-49m. Hence, we expect KMLOONG to easily maintain 60% pay-out ratio for FY17-18E DPS of 15.7-16.1 sen which translates to above-average dividend yields of 4.6-4.8% (small cap planters’ average 2.0%).

Earnings recovery on CPO price rally. As KMLOONG’s Sabah estates are impacted by the mid-2015 droughts, management expects flat yields in FY17 and normalisation by FY18. We estimate FY17-18E FFB growth of 2-9%, driven by maturing area in Sarawak and yield recovery in 2018. This is in line with our FY16-17E industry average growth forecast of 1-10%. Despite flattish production, we believe FY17E earnings should improve by 10% to RM81m as we expect CPO prices to increase 9% to average RM2,400/MT in 2016. This is in line with the small cap peers’ average FY16E earnings growth of 9%. In the short-term, we think the upcoming 1Q17 should see flat-to-better results, as CPO price improvement (QoQ: +17%, YoY: +15% to RM2,540/MT) should offset weaker FFB production (QoQ: -19%, YoY: -18% to 52.5k MT).

Trading Buy with Fair Value of RM3.66. We recommend a Trading Buy on KMLOONG with a Fair Value of RM3.66, based on a Fwd. PER of 14.0x applied to FY17E EPS of 26.1 sen. Our Fwd. PER of 14.0x implies a +1.0SD valuation basis which we believe is fair given KMLOONG’s long-term FFB growth prospect, solid balance sheet and consistent growth exceeding its small cap peers. We also note that our applied Fwd. PER at 14.0x represents a 32% discount to the small cap planters’ average Fwd. PER of 20.6x, demonstrating its undemanding current valuation.

Source: Kenanga Research - 9 Jun 2016