KLK has proposed to acquire 60% interest in PT Pinang Witmas Sejati (PWS) which holds two cultivation titles totalling 14,980 Ha in South Sumatera. Although we were slightly surprised by the timing of the acquisition, we were not surprised by the strategic move to acquire brownfield upstream assets given KLK’s consistent indications of expanding its plantation area. Upon completion, KLK’s planted area will increase by c.4%. Valuation of c.RM40k/planted Ha is in-line with previous transaction in South Sumatera (2015; c.RM38k) and KLK’s East Kalimantan transaction (2018; c.RM44k). No changes to FY20-21E CNP for now, pending further details from management. Maintain MP with an unchanged TP of RM19.20 based on CY20 PER of 26.2x (close to -1.0SD).

Acquires interest in South Sumatera. Kuala Lumpur Kepong (KLK) announced that it has entered into a conditional share sale and purchase agreement to acquire 60% stake in PT Pinang Witmas Sejati (PWS) for a total purchase consideration of RM341.55m. PWS holds two rights to cultivate (Hak Guna Usaha; HGU) for a total area of 14,980 Ha in South Sumatra, of which 14,106 Ha is planted. The HGU land also includes a 90/MT palm oil mill which supports PWS’ operations. The transaction is expected to be completed by 3QCY20, funded by existing cash reserves and bank borrowings.

Positive utilization of funds. Although we were slightly surprised by the timing of the acquisition (our previous meeting with KLK’s IR representative indicated that deals were on the back-burner), we were not surprised by the strategic move to acquire brownfield upstream assets as the group has been on the lookout for such acquisitions. The proposed 60% interest would effectively increase KLK’s planted area by c.4% to 238.6k Ha, which we believe is a good use of its proceeds from its RM2b Sukuk Wakalah in FY19. Valuation-wise, the purchase consideration translates into a EV/planted Ha of c.RM40,355, which we believe is fair compared to Oriental Holdings’ purchase of South Sumatera plantation assets at c.RM38,052/planted Ha in 2015. Note that KLK’s most recent purchase of East Kalimantan plantation assets in 2018 was also around the RM40,000 mark at c.RM43,789/planted Ha. All-in, we believe KLK’s willingness to pay the agreed EV/planted Ha valuation of c.RM40,355 signals its long-term favorable view on the plantation sector. Assuming a 30-70 debt-equity ratio, we expect FY20E net gearing to increase slightly to 0.39x (from 0.35x).

More clarity needed to ascertain earnings impact. Assuming 80% of the planted area is matured and FFB yield of 20mt/Ha, the acquisition could potentially increase KLK’s FY21 FFB output to 4.24m MT (+7.7% vs. +4.3% previously). Building on that with further assumptions of: (i) FY21 CPO price of RM2,300/MT, (ii) OER of 21%, and (iii) CPO production cost of RM1,600/MT, the additional FFB output could translate into an operating profit of c.RM20m (based on our back of the envelope calculation). Having said that, we made no changes to our FY20-21E CNP for now, pending further details from management.

Maintain MARKET PERFORM with an unchanged TP of RM19.20 pegged to 26.2x CY20E EPS of 73.1 sen. The Fwd. PER of 26.2x (close to -1.0SD) reflects its dim 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 - 27 Apr 2020