Kuala Lumpur Kepong Berhad (KLK) recorded 9M18 CNP* of RM736m, which was below both our forecast (at 64%) and consensus estimate (at 67%). No dividend was declared, as expected. We trim our FY18E CNP by 18% to RM942m as we moderate our previous optimistic downstream assumptions and raise tax rate by 2 ppt. Reiterate MARKET PERFORM with lower TP of RM24.20 (from RM25.20) based on an unchanged Fwd. PER of 22.4x.

Below expectations. 9M18 CNP* of RM736m (-13% YoY) came in below expectations as it accounted for 64% of our and 67% of consensus’ full-year estimates. The disappointment was attributable to lower-than-expected oleochemical margin. FFB production of 2.91m MT was in line at 73% of our projection. No dividend was declared during the quarter, as expected.

Hurt by weaker prices. The YoY drop in 9M18 CNP stemmed from weaker upstream earnings (-35% to RM659m) as marginal FFB output growth of 1% was unable to offset lower commodity prices (CPO: -13%; PK: -21%). Nevertheless, this was cushioned by a 2.5x jump in downstream earnings to RM384m, thanks to cheaper feedstock, particularly PK. Similarly, QoQ, 3Q18 CNP was flattish due to lower FFB output (-3%) as well as weaker commodity prices (CPO: -4%; PK: -18%), but offset by a 44% jump in oleochemical earnings (after stripping out unrealized derivatives loss of RM51m). We note that the group registered a higher effective tax rate of 31.0% in 3Q18 (vs. 27.9% in 2Q18), mainly due to an increase in withholding tax on foreign dividend and interest income.

Earnings to improve on higher volumes. Going into 4Q18, we believe earnings would pick up on higher seasonal FFB output and better downstream volume as higher crude oil prices (Brent crude oil: +11% YTD) improve the competitiveness of the group’s Methyl Ester- based products (such as detergents). In addition, PK at current price levels is favourable to downstream margins. Nevertheless, we reckon that this is insufficient to catch up with our CNP estimate of RM1.15b. Hence, we are trimming our FY18E CNP by 18%. Over the longer term, KLK’s earnings growth is expected to remain consistent in view of its stable organic and inorganic expansion tracks, including its ongoing plans to establish a new refinery in Indonesia and its bolt-on acquisitions in both upstream and downstream business segments.

Trimming FY18E CNP by 18% to RM942m as we moderate our previously optimistic FY18E downstream recovery expectations and raise our effective tax rate assumption to 26% from 24%. We are keeping our FY19E forecasts believing that FFB output growth (+8%) would improve as the effect of El Nino in 2015 and La Nina in 2016-17 subsides.

Maintain MARKET PERFORM with lower TP of RM24.20 (from RM25.20) accounting for lower average CY18-19E EPS of 107.8 sen applied to unchanged Fwd. PER of 22.4x. No change to our 3-year historical mean valuation basis as FY19E FFB production of 8% is in line with the peers’ average of 9%. KLK’s long-term prospects remain positive as management continues its hunt for M&A targets and plan to establish a JV refinery in Indonesia.

Risks to our call are sharp rises and falls in CPO prices and a precipitous rise in minimum wage.

Source: Kenanga Research - 15 Aug 2018