Sabah-based KRETAM is essentially an upstream palm oil group with some exposure to refining, biodiesel and compound fertiliser manufacturing. As its estates are fully RSPO certified, a substantial portion of its palm oil attracts premium prices. Its recent 1QFY23 earnings was weaker QoQ but firmer than several peers thanks to its premium CPO prices and healthy FFB harvest. We recommend a NEUTRAL call with FV of RM0.55 based on FY24F P/BV of 1.1x plus a 10% premium for its higher ROE.

Upstream. Based in Sabah, KRETAM has 24,744 Ha of land clustered mainly around Sandakan (11,512 Ha) but also in Lahad Datu (5,142 Ha) and Tawau (8,090 Ha) in Sabah of which 80% are already planted with oil palm, producing 300K-340K MT of FFB a year. As all its estates are RSPO, MSPO and German-backed ISCCcertified, about half of its palm oil is sold at premium prices to European buyers. The average age of its palm trees is 15-year, within the prime production age-bracket but a portion is advancing beyond 20 years old. As such, while the group can still look forward to betterthan-average FFB yields in Sabah, more aggressively replanting will be required within 3-5 years or earlier.

Downstream. The group’s upstream operation with bio-gas capture in Sandakan supports an integrated downstream facility comprising of a refinery and biodiesel plant. The group also runs two fertiliser facilities, one for composting and another is a compound fertiliser manufacturing plant. Downstream margins of 5%-7% are expected.

Slower FY23F earnings ahead. Weaker CPO prices of RM3,700 per MT for the plantation sector is expected for CY23-24. KRETAM should enjoy slightly better prices as about half of its palm oil attracts premium prices. Encouraging 1QFY23 harvest of 95,764 MT (-11% QoQ, +27% YoY) further suggests that stronger YoY FY23F FFB output is likely (note that the total Malaysian palm oil output was down 22% QoQ and rose only 3% YoY during the same 3-month). Unit costs have risen since FY22 but lower fertiliser prices should ease rising cost pressure in 2HFY23F. Overall, FY23F earnings are expected to still dip YoY before recovering in FY24F.

Expansion? KRETAM ended 1QFY23 with net cash of RM39m but with no strict dividend policy or steady payout precedent, expansion is probably more likely. However, good upstream oil palm assets are not easy to come by, hence downstream expansion cannot be ruled out. Recently, on 29 May 2023, KRETAM announced it has taken a 5.9% stake in Bahvest Resources, an ACE-listed gold mining company.

We recommend NEUTRAL on KRETAM with a RM0.55 FV. In view ot the CPO and earnings downtrend, many of our latest plantation companies’ target prices are derived based on P/BV rather than PER. Moreover, KRETAM’s historical earnings have also been volatile, from loss making in FY17-19 to recent strong profits. As such, our FV of RM0.55 is based on the plantation sector average of 1.1x P/BV on its FY24F book value plus a 10% premium for its higher ROE of 9% versus 7% for the sector.

Risks to our call include: (i) weather impact on edible oil supply, (ii) unfavourable commodity prices fluctuations, and (iii) cost inflation.

Source: Kenanga Research - 7 Jun 2023