CB Industrial Product (CBIP) has received a qualified audit opinion from its external auditors. We are mildly negative but believe that there should be minimal impact to FY18 numbers. Meanwhile, acquisition of Gulf Lubes would drag earnings with LATAMI of c.RM8.0 as the biodiesel plants are likely at suboptimal capacity in FY19. Reduce FY19E CNP by 13% but raise FY20E CNP by 6%. Downgrade to MARKET PERFORM with a lower TP of RM1.10.

Qualified audit opinion. CBIP announced that it has received a qualified audit opinion from its external auditors, Messrs. Crowe Malaysia PLT. The basis for the qualified opinion was due to the unavailability of audited financial statements and auditors’ report for its associates (Bahtera Bahagia Sdn. Bhd. and Kumpulan Kris Jati Sdn. Bhd.) and a joint-venture (JV) Pride Palm Oil Mill Sdn. Bhd., mainly because of a delay in completion of the associates and JV’s management accounts from the adoption and transition to the new Malaysia Financial Reporting Standards (MFRS).

Fault lies on the associate and JV. We are mildly negative on the news as it may create a short-term misperception towards the stock. However, we wish to clarify that for CBIP itself, there has been no issue with its own set of financial statements, and the delay in the completion of the associates and JV’s management accounts should pose minimal impact to FY18 numbers. To recap, in FY18, reported losses from its share of associates and JV stood at RM0.8m and RM4.1m, respectively.

Acquisition of biofuel facility. On a separate note, CBIP announced that it has acquired 63.67m shares, while its 80%-owned TPG Oil & Gas Sdn Bhd has acquired 6.33m shares, in Gulf Lubes Malaysia Sdn Bhd (Gulf Lubes), representing an aggregate stake of 70% for a total cash consideration RM2.11m. Gulf Lubes owns 2 biodiesel processing plants with total annual production capacity of 350k MT and a refined, bleached and deodorised (RBD) palm oil processing plant with annual production capacity of 250k MT. Gulf Lubes made a loss of RM24.28m in FY18. The acquisition would allow CBIP to capitalise on potential increase in biodiesel demand fueled by the B10 biodiesel mandate for the transportation sector and B7 for the industrial sector introduced in late-2018.

Unexciting contribution from biodiesel plants initially. Despite the long-term potential, we believe the biodiesel plants would run at suboptimal capacity currently as they require refurbishment before commencing its maiden production (likely in July 2019) and expected to remain loss-making in FY19. The plants have been left idle since construction in 2009. Based on our 30% utilisation rate assumption for its biodiesel facility, and a biodiesel price of RM2.30/litre, we estimate that Gulf Lubes would contribute c.RM8.0 loss after tax and minority interests (LATAMI) in FY19. For its RBD palm oil plant, we understand that it remains idle for now.

Reduce FY19E CNP by 13% but raise FY20E CNP by 6% to RM RM49.6-67.3m as we expect suboptimal utilisation of its biodiesel plants in FY19, with improvement as well as full contribution in FY20. Downgrade to MARKET PERFORM (from OUTPERFORM) with a lower Target Price of RM1.10 (vs. RM1.25) based on an unchanged Fwd. PER of 11.3x applied to FY19E EPS of 9.6 sen. Our Fwd. PER reflects -0.5SD vs. average of -1.0SD (range: -2.0SD to +0.5SD) for other planters under our coverage, warranted by CBIP’s torrent of contract flows lately.

Risks to our call include: lower/higher-than-expected raw material cost, lower/higher-than-expected order-book replenishment, and lower/higher-than-expected plantation losses.

Source: Kenanga Research - 6 May 2019