KLK’s 2Q19 CNP* came in markedly below expectations at RM114m (-44% YoY; -41% QoQ), bringing 1H19 CNP to RM309m (-43% YoY). The 1H19 CNP only accounted for 34% of consensus full-year estimate and 27% of ours, no thanks to lower-than-expected CPO and PK prices. An interim dividend of 15.0 sen was announced, as expected. Slash FY19-20E CNPs by 25-19% to RM860-976m. Downgrade to UP with a lower TP of RM22.00.

A big negative surprise. Kuala Lumpur Kepong Berhad (KLK)’s 2Q19 core net profit* (CNP) came in markedly below expectations at RM114m (-44% YoY; -41% QoQ), bringing 1H19 CNP to RM309m (- 43% YoY). 1H19 CNP only accounted for 34% of consensus full-year estimate and 27% of ours, no thanks to lower-than-expected CPO (RM1,906/MT in 1H19 vs. our FY19E forecast of RM2,375/MT) and PK (RM1,340/MT in 1H19 vs. our FY19E forecast of RM1,650/MT) prices. On the other hand, FFB production of 2.09m MT (+6% YoY) was within expectation, accounting for 51% of our 4.11m MT estimate. An interim dividend of 15.0 sen was announced, as expected.

Tough quarter. YoY, 2Q19 CNP plummeted 44% mainly due to lower operating profit in the Plantation segment (-56% to RM101m) amid a 18% drop in the average CPO price to RM1,969/MT and a 37% plunge in the average PK price to RM1,301/MT. This was in spite of a 3% increase in FFB production. Notwithstanding cheaper feedstock, Downstream Manufacturing profit also declined, by 18%, as margins waned amid stiff competition from Indonesia. QoQ, despite a 7% increase in average CPO price, 2Q19 CNP plunged by similar quantum (-41%) as FFB declined 11% on seasonality.

Challenging times ahead. We believe earnings will remain weak in subsequent quarters as CPO price is unlikely to see a meaningful recovery in 2H19 amid burgeoning stockpiles. Nevertheless, over the longer term, KLK’s earnings growth is expected to remain consistent in view of its stable organic and inorganic expansion tracks. The group continues to be on the lookout for acquisitions in the upstream segment, with preference for brownfield oil palm plantations with flat/low-lying land.

Slash FY19-20E CNPs by 25-19% to RM860-976m as we cut CPO estimates from RM2,375-2,400/MT to RM1,960-2,150/MT; and PK price assumptions from RM1,650-1,700/MT to RM1,400-1,450/MT.

Downgrade to UNDERPERFORM with a lower Target Price of RM22.00 (previously MARKET PERFORM, Target Price: RM25.70) pegged at 23.5x CY20E EPS of 93.7 sen (rolled forward from CY19E). Our Fwd. PER of 23.5x (-2.0SD, trough level) reflects its CY20E FFB growth prospects of 4% as well as its large-cap and FBMKLCI inclusion statuses. While KLK’s long-term prospects remain stable as management continues its hunt for M&A targets, we believe near-term earnings will be impeded by the depressed CPO price environment currently.

Risks to our call are sharp rises in CPO prices and a significant drop in fertiliser/transportation costs.

Source: Kenanga Research - 16 May 2019