Kuala Lumpur Kepong Berhad’s (KLK) 1H17 Core Net Profit* (CNP) at RM663m came in slightly above estimates at 56% of consensus and 58% of our forecast thanks to stronger CPO and PK prices. An interim dividend of 15.0 sen was declared, in line with historical trends. We revise up our FY17-18E CNP by 5-4% to RM1.20-1.21b on updated PK contribution estimates. Maintain MARKET PERFORM with higher TP of RM26.56 (from RM26.00).

1H17 exceeds expectations. KLK recorded 1H17 CNP of RM663m, which was slightly above consensus’ full-year estimate of RM1.19b at 56%, and above our forecasted RM1.15b at 58%. This was largely due to higher year-to-date (YtD) CPO prices (+37% to RM2,851/metric ton (MT)) as well as a jump in PK prices (+82% to RM2,871/MT). FFB production at 1.95m MT was in line with our estimated 3.91m MT at 50%. An interim dividend of 15.0 sen was declared, matching previous years’ payment. We expect a higher dividend in 4Q17, in line with historical patterns.

Price perk. YoY, CNP improved 29% as upstream operating profit doubled to RM786m on the back of stronger CPO and FFB prices, as discussed above. FFB volume also improved (+7%) as 2015 drought effects faded. Downstream contribution, however, fell 56% to RM102m on a core basis (excluding derivatives translation gains) as higher PK prices resulted in higher input cost, causing margins to drop to 2.1% from 6.4%. QoQ, CNP softened 20% as upstream contribution weakened 14% as CPO and PK price appreciation (+10% and +17%, respectively) failed to offset seasonally lower production (-13%). Downstream core operating profit also weakened 13% on higher input cost and softer product demand as buyers anticipated price declines.

Neutral mid-term outlook. We are overall neutral on KLK’s prospects in 2H17 as softer upstream performance (due to lower CPO prices) should be offset by better downstream margins (thanks to lower cost of PK input). Meanwhile, over the longer term, we believe KLK has demonstrated its appetite for M&A with its bid on MP Evans. Hence, we would not be surprised to see fresh efforts from KLK to expand its plantation landbank within FY17-18. While the earnings impact would be dependent on pricing, we would be long-term positive on landbank expansion considering the increasing scarcity of plantation area, which also meets sustainability criteria.

Upgrade FY17-18E CNP by 5-4% to RM1.20-1.21b as we update our PK price assumptions to reflect the 2016 run-up. Refining margins also adjusted slightly higher to reflect positive margins from higher local CPO tax structure.

Maintain MARKET PERFORM with higher TP of RM26.56 (from RM26.00). In tandem with our earnings upgrade, we also roll forward our valuation base year to average CY17-18E (from CY17E) for higher Fwd. EPS of 113.0 sen (from 108.4) sen. We tweak our applied Fwd. PER to 23.5x (from 24.0x) on updated earnings, while our mean valuation basis is unchanged. We expect the improving downstream prospect to offset softer upstream contribution and weaker investor sentiment, given that CPO prices are likely to reverse in 2H17. As a result, we maintain our MARKET PERFORM call on KLK.

Source: Kenanga Research - 23 May 2017