Kuala Lumpur Kepong Berhad (KLK)’s FY18 CNP* of RM892m is broadly within our forecast at 95%, but below consensus estimate at 93%. A final dividend will be announced at a later date (we expect 35.0 sen), which is an unprecedented practice. Moving forward, we expect earnings to recover on higher FFB output (FY19E: +5%) and better downstream volume. No changes in FY19E CNP of RM1.15b, introduce FY20E CNP of RM1.20b. Maintain MARKET PERFORM with TP of RM25.70.

Broadly within expectations. KLK’s FY18 core net profit* (CNP) of RM892m (-17% YoY) is broadly in line with our forecast of RM942m at 95%, but slightly below consensus estimate of RM963m at 93%, likely due to lower-than-expected CPO prices. Note that we have, among others, excluded surplus on government acquisition of land of RM24.0m, impairment of PPE of RM21.6m and FX loss of RM41.1m in our CNP calculation. FFB production of 3.93m MT is also within our expectation, coming in merely 1% shy of our projection of 3.98m MT. A final dividend for FY18 will be announced at a later date, which is unprecedented as the final dividend has always been proposed in 4Q. We expect KLK to announce a 35.0 sen final dividend, bringing FY18 dividend to 50.0 sen (flat from last year).

Saved by Oleochemical. YoY, FY18 CNP fell 17% mainly due to lower operating profit in the Plantation segment (-46% to RM711m) following a 15% drop in CPO price to RM2,335/MT as well as losses incurred by processing and trading operations, marginally mitigated by a 1% increase in FFB production. This was partially cushioned by a 2.2x increase in Manufacturing profit to RM434m, driven by Oleochemical division (+3.2x to RM368m) thanks to cheaper feedstock. On a quarterly basis, 4Q18 CNP dropped by a larger quantum (-31% to RM157m) due to a poorer performance in Europe’s Manufacturing operations on narrower margins and lower sales volume. QoQ, 4Q18 CNP was down 20% despite a 10% increase in FFB output due to lower CPO price (-11% to RM2,060/MT) and a higher effective tax rate of 39.1% (vs. 31% in 3Q18). The increase in tax rate was attributable to a higher amount of expenses not deductible for tax purposes.

Earnings to improve on higher volumes. Moving forward, we believe earnings would recover on higher FFB output (FY19E: +5%) and better downstream volume as the current CPO-to-crude oil discount of c.USD30 (vs. an average premium of c.USD65 in the past one year) improves 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. 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.

No changes in FY19E CNP of RM1.15b as earnings were in line with expectations. We introduce FY20E CNP of RM1.20b, which represents growth of 5%, underpinned by KLK’s FFB growth prospects of 4%.

Maintain MARKET PERFORM with an unchanged TP of RM25.70 pegged to 23.5x CY19E EPS of 109.2 sen. Our Fwd. PER of 23.5x reflects its CY19E FFB growth prospects of 5% and its large-cap and FBMKLCI inclusion statuses. KLK’s long-term prospects remain positive as management continues its hunt for M&A targets and plans to establish a JV refinery in Indonesia. Risks to our call are sharp falls/rises in CPO prices and a precipitous rise in minimum wage.

Source: Kenanga Research - 15 Nov 2018