We came away from a meeting with Kuala Lumpur Kepong (KLK)’s IR representative, Ms. Lim Poh Poh unenthused about its immediate-term prospects. 1Q19 earnings could see some weakness amid soft CPO prices and narrowing Oleochemical margins. FY19E FFB growth is guided at 5-6%, while average CPO price is seen at RM2,200-2300/MT. No change in FY18-19E CNPs of RM1.15-1.20b. Maintain MARKET PERFORM with unchanged TP of RM25.70.

Expect soft patch in 1Q19. We believe a drop in CPO prices, estimated at 12% QoQ, would outweigh the effect of an 8% FFB growth in 1Q19. Additionally, margins in the Oleochemical division have most likely waned due to competition from Indonesia and a sharp drop in crude oil prices, which make the group’s Methyl Ester-based products less attractive. As such, we expect the group to hit a soft patch in 1Q19, potentially being the weakest quarter in FY19. However, we believe the results will still be broadly in line with expectations, considering that CPO prices have been recovering handsomely of late while fertliser application is normally front-loaded.

Decent FFB growth outlook. Management sees Indonesian FFB growth in the teens, driven by maturing young trees; and low single digit for Malaysia in FY19. Overall, this should translate into 5-6% blended FFB growth for the group, pushing output beyond the 4.0m mark in FY19, in line with our forecast. About 7,000-8,000 Ha of oil palms – mostly from Indonesia – is expected to come into maturity in FY19, but the increase would be more than offset by a 10,000 Ha replanting target.

Cost contained. While the new minimum wage set by Malaysia is expected to increase cost of production by c.RM20/MT, a 5-10% raise in Indonesian wages – from current levels of RM550-750/month in Kalimantan and Sumatra – should have a minimal impact as the majority of estate workers are already receiving RM800/month and above. We also understand that the group has locked in its fertiliser requirements for FY19 at similar prices to FY18’s. Considering moderate output growth, we estimate FY19E ex-mill cost of production at RM1,370/MT, flat from FY18.

Cautious on CPO price. The group expects CPO price to range between RM2,200/MT and RM2,300/MT in 2019, as feedback from its marketing team suggests that customers are still in cautious buying mode. On the other hand, we are sticking to our slightly more bullish forecast of RM2,400/MT, premised on additional demand from biodiesel initiatives.

Still shopping. The group continues to be on the lookout for acquisitions in the upstream segment, with the preference for brownfield oil palm plantations with flat/low-lying land. These potential acquisitions, coupled the group’s organic expansion tracks, should support consistent earnings growth over the long term.

No change in FY18-FY19E CNPs of RM1.15-1.20b as CPO prices continue to rise in tandem with expectations, and FFB outlook guidance is in line with our forecast.

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 (- 2.0 SD) reflects its CY19E FFB growth prospects of 5% as well as its large-cap and FBMKLCI inclusion statuses. While KLK’s long-term prospects remain positive as management continues its hunt for M&A targets, we do not see any excitement in the near-term given its average production outlook and a competitive environment in the Oleochemical segment.

Risks to our call are sharp falls/rises in CPO prices and a precipitous rise/drop in labour/fertiliser/transportation costs.

Source: Kenanga Research - 29 Jan 2019