Reuters reported (on 4 Nov) that KLK is considering raising its 21% stake in UK associate, Synthomer plc. Synthomer’s rubber polymer business has a long history with Malaysia and KLK, hence Synthomer is not new to KLK. Its net gearing is a concern and Europe is facing major headwinds for a year or two. However, trading at 6x FY23F PER, a higher stake should prove neutral to earnings accretive besides providing KLK with greater flexibility with its holding moving forward. Maintain OUTPERFORM and TP of RM28.00 pending 4QFY22 results on 23 Nov.

Background on Synthomer: Formerly Yule Catto & Co plc, Synthomer is a performance polymer specialist with a leading global position in Acrylonitrile Butadiene Rubber (NBR) latex used in glove-dipping. Hence, the sharp PATMI turnaround, from £3m in FY20 to £210m in FY21 (Synthomer’s FY ends in Dec). In April 2022, Synthomer paid

£760m for Eastman’s Adhesive Resins (AR) unit which pushed net debt from £158m (15% net gearing) at end FY21 to £1,041m (92% net gearing) by 1HFY22. Forward earnings should be stronger with AR but weak economic outlook for Europe is dampening earnings for a year or two. Therefore, consensus is expecting Synthomer’s PATMI to likely dip from £121m in FY22 to £104m in FY23 before recovering in FY24 to £143m. All in all, this is still above FY16-20 average annual PATMI of £76m but below an exceptional FY21 PATMI of £209m.

Possible scenarios: The objective for such a possible move is unclear at this juncture. It may be opportunistic given the undemanding valuations but can equally be part of longer-term strategic plan given Synthomer’s specialty polymer cum chemical expertise in the non-food segment plus greater presence in North America whereas KLK is stronger in Asia and Europe focusing more on palm-based food products. Therefore, some of the possible scenarios are:

a)Given its current holding of 21%, KLK may buy up to 30% without triggering UK’s Mandatory General Offer (MGO) limit. However, KLK is reportedly seeking financial advice which would suggest beyond simple open market accumulation.

b)Outright cash MGO buyout is within KLK’s reach though its balance sheet would end up being stretched. Synthomer’s net debt in June stood at £1,041m and an MGO may cost around £593m assuming a 30% takeover premium to Friday’s closing price of £1.236. Together with KLK’s existing RM7b net debt, a 100% buyout would easily double KLK’s net debt to RM16b with net gearing rising to 120%.

c) Synthomer may also be part of a restructuring exercise involving KLK’s other downstream assets. This could be implemented upfront or carried out in phases with accumulation in Synthomer shares as a stepping stone. A separately listed downstream unit can minimise some risks and create value over the long term. Presently, the group’s upstream and downstream segments share the same economic and reputational prospects even if only the upstream operation faces ESG concerns or CPO price weakness.

Maintain OUTPERFORM and TP of RM28.00. Given that full-year’s results is pending on 23 Nov, FY22 is as good as done and we are comfortable with our FY22F core NP of RM2,041m. FY23 earnings should trend down with or without a higher stake in Synthomer due to weaker CPO prices, which should decline from RM4,500/MT in 2022 to RM4,000/MT in 2023. The RM28.00 TP is based on 15x FY23F CEPS to reflect historic integrated ratings plus a 5% premium to in view of the group’s 4-star ESG score.

Source: Kenanga Research - 7 Nov 2022