KLK’s 9M16 CNP at RM737m missed expectations, at 69% of consensus and 67% of our forecast, due to disappointing FFB production (66% of FY16E) and flat CPO prices (+2% YoY-Ytd). No dividend declared, as expected. We reduce our FY16-17E earnings by 10-7% to RM989m-1.10b on lower FFB production outlook, consequently reducing our TP to RM25.00. However, we maintain OUTPERFORM on strong 4Q16 expectations in both upstream and downstream segments.

9M16 misses expectations. Kuala Lumpur Kepong (KLK)’s 9M16 core net profit (CNP*) missed consensus (RM1.06b) and our forecast (RM1.10b) at 69% and 67%, respectively. This was mainly due to weaker production, which made up only 66% of our full-year forecast. In comparison, 9M16 production historically averaged 73% of actual full-year production. 9M16 CPO average price at RM2,199/metric ton (MT) was also below ours and consensus CY16E CPO price of RM2,400/MT. No dividend was announced in line with previous years’ dividend trends.

Weak volumes, but good prices. QoQ - despite flat FFB volume at 771k MT, 3Q16 CNP jumped 50%, driven by a 13% improvement in CPO prices, which led to a 65% rise in Plantation EBIT. Higher CPO prices and PK prices (+21%) also led to 40% higher Manufacturing Core EBIT (excluding unrealised derivatives loss). YoY-Ytd – CNP improved 17% mainly driven by Manufacturing EBIT, which soared 87% on higher PK prices (+17%) as well as better sales volume in Europe. Plantation EBIT was relatively unchanged (+2%) on flattish CPO prices (+2%) and weaker FFB volume (- 6%) on lingering drought effects.

Supportive price offsets softer production. On the upstream side, while we expect 3Q16 production to pick up against 2Q16, we reduce our FY16E full-year FFB growth (+3%) forecast to a production decline (-5%) due to slower-than-expected production recovery in the previous quarter. However, FY17E FFB growth is increased to +8% (from +5%) due to low base effect. Meanwhile, low inventory levels remain supportive to CPO prices in early- 3Q16, with quarter-to-date (QTD) CPO prices at RM2,424/MT being 7% lower QoQ but 18% higher YoY. Given our production expectation of +31% QoQ and -3% YoY, we think the upstream segment should perform strongly both QoQ and YoY in 4Q16.

Downstream outlook favourable. We gather that while CPKO-based fatty alcohol business is seeing lower demand due to high prices, management expects favourable results in oleochemical businesses due to additional plant capacities, operational efficiency and productivity improvement. We also note the better demand in Europe, indicating that KLK could continue to benefit from the suspension of IOICORP’s RSPO certification, which appears to have led IOICORP customers to switch to KLK and other major downstream players with European facilities, such as SIME and Wilmar.

FY16-17E CNP reduced 10-7% to RM989m-1.10b on lower FFB production outlook as discussed above.

Maintain OUTPERFORM with lower TP of RM25.00 (from RM26.17) as we account for lower earnings while rolling forward our valuation base year to CY17 (from average CY16-17E), which results in lower Fwd. EPS of 104.2 sen (from 109.0 sen). Our Fwd. PER is maintained at 24.0x, implying mean valuation. We believe this is fair as KLK’s weaker FFB production outlook is offset by stronger downstream prospect. We maintain our OUTPERFORM call as we expect a better 4Q16 due to seasonal production pickup, supportive CPO prices and continued strong downstream demand.

Source: Kenanga Research - 18 Aug 2016