We came away from a meeting with Kuala Lumpur Kepong (KLK)’s IR representative unenthused about its immediate term prospects. While 2QFY20 earnings should see sequential improvement (CPO price: +23% QoQ), its FY20 FFB outlook remains unexciting. As a result of lower FFB, CPO production cost is expected to creep up to RM1,500/MT. FY20 budgeted CPO price of RM2,200/MT remains unchanged. Reduce FY20-21E CNP by 10-8% on lower FY20-21E FFB output (now implying growth of -4.1% and +4.3%), lower downstream and property sales (-14%/- 10%). Downgrade to MP with a lower TP of RM19.20 (from RM21.30) based on CY20 PER of 26.2x (close to -1.0SD).

Expecting sequential earnings improvement in 2QFY20. Based on Bursa announcements, its 2QFY20 FFB output has fallen (-10% YoY; - 9% QoQ) to 891k MT. Despite that, we believe the effect of higher CPO prices, estimated at 23% QoQ would outweigh the decline in FFB output leading to sequentially higher earnings in 2QFY20. Additionally, margins in Oleochemical division should remain relatively stable, albeit dipping slightly as we understand the group has purchased enough feedstock for requirements up to 2QFY20 pre-CPO price rally. On reasons mentioned above, we estimate 2QFY20 earnings to potentially come within the range of RM185-190m.

Unexciting outlook - flat FFB growth at best. The group maintains FY20 FFB target of 4.1m MT (flat YoY growth), implying 54% of full year FFB output in 2HFY20. We think that this is a tall order to achieve considering that historically (over 3 years), 2HFY FFB output accounted for an average 49% of full-year figure and has never breached the 50% mark. We believe c.3.9-4.0m MT (-5% to -2% YoY) is a more feasible figure to achieve and have adjusted our FFB assumptions accordingly

(refer to earnings estimate below). We also highlight here that given the increasing number of COVID-19 cases in Indonesia, a lockdown extension to other regions remains a downside risk. Note that Indonesia accounts for c.50-55% of planted area for KLK which is expected to drive growth given its average age profile of c.12 years.

Staying cautious on CPO price. The group expects CPO price to range between RM2,100-2,200/MT in the near term, as response from its marketing team suggests that customers have not cancelled orders. However, the group pointed out that it would not be surprised if CPO price breaches below RM2,000/MT in the short term. Its FY20 budgeted CPO price of RM2,200/MT remains unrevised. Meanwhile, we believe FY20 CPO production cost should creep up to c.RM1,500/MT (from RM1,400/MT in FY19) due to lower FFB output. The group has also locked in flat fertilizer cost up to June-July 2020.

Cut FY20-21E CNPs by 10-8% as we: (i) lowered FY20-21E FFB output to 3.93-4.10m MT, implying -4.1% and +4.3% YoY growth (from -2.3% and +3.3% YoY), (ii) reduced downstream sales by 14%, and (ii) lowered property sales by 10%.

Downgrade to MARKET PERFORM with a lower TP of RM19.20 (from RM21.30) pegged to 26.2x CY20E EPS of 73.1 sen. Our Fwd. PER of 26.2x (close to -1.0 SD) reflects its flat FFB growth outlook as well as its large-cap and FBMKLCI inclusion statuses. While KLK’s long-term prospects remain intact, we do not see any excitement in the near-term given its dim production outlook and 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 - 24 Apr 2020