We came away from a meeting with Kuala Lumpur Kepong (KLK)’s IR representative excited about its FY21 prospects. FFB growth of 10- 15% (upside to our 6%) is the key positive takeaway. FY21E CPO price is seen at RM2,500/MT, while production cost is expected to decline to RM1,350/MT on higher production. We anticipate sequential earnings improvement in 4QFY20 (est. RM212m) on higher CPO price and FFB output. Raise FY21 CNP by 4% on higher FFB growth. Reiterate OP with higher TP of RM26.00 (from RM25.00) based on FY21E PER of 30x (-0.5SD).

Exciting FFB growth prospect of 10-15%. The group is targeting FY21 FFB growth of 10% on an industry-wide production recovery from a low season with potential boost from La Niña. This target excludes contributions from the acquisition of PWS (60% stake) and TSH’s FB & TSS estates (90% stake), both of which are in Indonesia and have yet to be completed. Adding contributions from PWS, FB & TSS, FY21 FFB growth could potentially be higher at 15%. This upside to our FY21 FFB growth of 6% is the key positive takeaway. To recap, the completion of PWS’ acquisition was initially expected to be in 4QFY20 but is now pushed later to 1Q-2QFY21 as discussions with the minority shareholders are still on-going. Acquisition of FB & TSS estates is on track to be completed by 2QFY21. Upon completion of both acquisitions, KLK’s total planted area would increase by c.8% to c.236k Ha, while its geographical mix of estates in Indonesia would increase to c.58% (vs. c.55% previously).

FY21E CPO price seen at RM2,500/MT. This is in line with our view that CPO price is likely to trend lower in the next few months. Our CY21 CPO price forecast of RM2,600/MT remains unchanged. We understand that forward sales for KLK typically constitute 20-30% of production and contracted for 2-3 months ahead. Meanwhile, the group’s FY21 production cost is guided at RM1,350/MT (vs. est. RM1,500 in FY20) as a result of strong FFB growth, and slight increase in fertilizer cost. On the issue of labour shortage, we gathered that while there is a shortfall of 5-8% of the required workforce in Peninsular estates (25% of group’s total production), the shortage, on a group level, is manageable. In fact, the labour-to-hectare ratio has improved to 1:9 (from 1:8 previously) and the group targets improvement to 1:10 in the next 2-3 years.

Positive downstream demand outlook. While the group believes feedstock prices are likely to be volatile in FY21, we were assured that FY21 demand for oleochemicals will remain strong, especially for home/personal care (i.e.: soaps, detergents and hand sanitizers) given the higher standards of hygiene/precautionary measures. We believe utilization rates at its plants in Malaysia, China and Europe are at 100%, 90-95% and 90%, respectively.

Expecting a stronger 4QFY20. With higher average CPO price (MPOB: +22% QoQ) alongside higher FFB/CPO output (+3%/+3% QoQ), we anticipate sequential earnings improvement for KLK. Based on our estimates, implied 4QFY20 CNP is RM212m (+8% QoQ/+37% YoY).

Raise FY21E CNP by 4% on higher FY21E FFB growth of 12% (vs. 6% previously).

Reiterate OUTPERFORM with a higher TP of RM26.00 (from RM25.00) based on unchanged FY21E PER of 30x (in-line with large cap peers’ average), reflecting -0.5SD valuation. At current price, KLK is trading at FY21E PER of merely 25x (below -1.5SD), which we believe is unjustified given its: (i) integrated status which offers more earnings stability, (ii) strong FY21E FFB growth of 10-15%, and (iii) strong oleochemicals demand outlook. Risks to our call are: (i) sharp decline in CPO prices, and (ii) a precipitous rise in labour/fertiliser/transportation costs.

Source: Kenanga Research - 21 Oct 2020