KLK’s 3Q19 CNP* came in below expectations at RM155m (- 20% YoY; +35% QoQ), bringing 9M19 CNP to RM464m (-32% YoY), forming 63% of consensus full-year estimate and 54% of ours due to lower-than-expected Downstream margins. FFB production of 3.05m MT (+5% YoY) is within expectation. No dividend was announced, as expected. Slash FY19-20E CNP by 23-14% to RM665-840m. Maintain UNDERPERFORM with a lower TP of RM21.50.

Back-to-back miss. Kuala Lumpur Kepong Berhad (KLK)’s 3Q19 core net profit* (CNP) came in below expectations at RM155m (-20% YoY; +35% QoQ). This brought 9M19 CNP to RM464m (-32% YoY), accounting for 63% of consensus full-year estimate and only 54% of ours, no thanks to lower-than-expected Downstream margins (4.3% in 9M19 vs. our assumption of 6%). FFB production of 3.05m MT (+5% YoY) is within expectation, accounting for 74% of our 4.11m MT estimate. No dividend was announced, as expected. Note that the quarter recorded RM145.3m impairment of an estate located in Sinoe County, Liberia, as recent High Carbon Stock and High Conservation Value assessments suggest that there is limited plantable area in the estate rendering it infeasible to continue operations.

Downstream not helping enough. YoY, despite 5% FFB growth, 9M19 CNP fell 32% mainly on 21%/40% plunge in the average CPO/PK prices. Additionally, Downstream profits paralleled a 13% revenue contraction due to lower selling prices. QoQ, despite a 3% drop in FFB and flattish CPO price, CNP improved 35% on the recognition of RM40m dividend income from investments in Synthomer plc and M.P. Evans Group, as well as a 6% improvement in Downstream profits thanks to cheaper feedstock.

Challenging times to stay. KLK’s earnings outlook remains bleak in the near-term as the CPO price upside is likely capped by burgeoning stockpiles in 4QCY19 and India’s probe into Malaysian exports of refined palm oil (which, in a grey sky scenario, could lead to protectionism and lower palm oil imports from India). 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 CNP by 23-14% to RM665-840m as we cut Downstream margin assumptions from 6.0-5.0% to 4.0-4.0% on account of lower oleochemical offtake in the Europe.

Maintain UNDERPERFORM with a lower TP of RM21.50 (from RM22.00) based on CY20E PBV of 2.1x, implying -2.0SD given back to-back earnings disappointment and tough operating environment. We have switched our valuation method from PER to PBV due to recent earnings volatility. Our TP implies a CY20E PER of 26.6x. 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 unexciting CPO price environment.

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

Source: Kenanga Research - 21 Aug 2019