3MFY20 CNP of RM179m (-8% YoY; +22% QoQ) came in below our (17%) and consensus (20%) estimates due to: (i) lower than-expected FFB output at 23% of our full-year estimate (which also resulted in higher CPO cost), and (ii) lower-than expected CPO price realized (likely due to forward selling). Reduce FY20-21E CNP by 12-13% on lower FY20-21E FFB output (-6%/-7%) and higher CPO production cost (+3%). Despite lower TP of RM28.80, KLK is still an OUTPERFORM, only trading at CY20 PER of 26.4x, implying a mere -0.5SD from mean (vs. +1SD in 2017), even with the recent CPO price rally.

1QFY20 below expectations. Kuala Lumpur Kepong Berhad (KLK)’s 1QFY20 core net profit* (CNP) came in below expectations at RM179m (-8% YoY; +22% QoQ), accounting for only 17%/20% of our/consensus’ estimates. The negative deviation stemmed from: (i) lower-than-expected 1QFY20 FFB production of 998k MT (-7% QoQ; - 12% YoY) accounting for 23% of our full-year estimate of 4.28m MT due to the dry weather impact (historically 1QFY20 FFB accounted for 27% of the full-year production), (ii) higher-than-expected CPO production cost as a result of lower FFB output, and (iii) lower-than expected CPO price realized, which we believe could be due to some forward selling. No dividend was declared, as expected.

YoY, despite 20% increase in CPO price to RM2,207/MT, 3MFY20 CNP fell (-8%) as a result of: (i) lower FFB output (-12%), (ii) lower PK price of RM1,247/MT (-9%), (iii) 16% decline in profit from manufacturing segment on the back of higher CPO price, and (iv) losses of RM5m from its investment holdings segment (farming sector) as compared to profit of RM49m in 1QFY19, as profits from farming sector fell 86% to RM8.1m due to unfavorable weather conditions. QoQ, CNP improved (+22%) due to higher CPO price (+15%), and higher PK price (+17%). The increase would have been more significant if not for a decline (-7%) in FFB output.

Still positive. Despite the miss in FFB production and our revision in FFB forecasts (refer to paragraph below), we believe KLK may register sequential earnings improvement in 2QFY20 premised on higher average CPO price (MPOB QTD2QFY20: +17% QoQ), as planters earnings are more sensitive to changes in CPO price. Over the longer term, KLK’s earnings growth is expected to remain consistent in view of its stable organic and inorganic expansion tracks. Meanwhile, the group continues to be on the lookout for acquisitions in the upstream segment, preferring brown-field oil palm plantations with flat/low-lying land.

Reduced FY20-21E CNP by 12-13% to RM927-1053m as we lowered FY20-21E FFB output by 6-7% and increase CPO production cost by 3% to RM1,550/MT.

Still an OUTPERFORM, but with lower TP of RM28.80 based on CY20E PER of 32x, reflecting +0.5D valuation. At current price, KLK is only trading at CY20E PER of 26.4x (at c.8% discount to its large cap peers), and implying a mere -0.5SD from mean which we believe is unjustified given: (i) the recent CPO price rally (during a similar CPO price rally in 2017, KLK was traded at +1SD), (ii) its above-sector average FY20 ROE of 8.8% (vs. sector’s average of c.6%), and, (iii) decent dividend yield of 2.3%.

Risks to our call are sharp decline in CPO prices and significant increase in fertiliser/transportation costs.

Source: Kenanga Research - 18 Feb 2020