Kenanga Research & Investment

Kuala Lumpur Kepong - Downstream Drags

Publish date: Wed, 21 Feb 2024, 11:51 AM

KLK’s 1QFY24 results disappointed. Its upstream earnings were good despite flattish CPO prices QoQ, but its downstream operations continued to struggle. We cut our FY24-25F net profit forecasts by 23% and 16% respectively, reduce our TP by 6% to RM23.00 (from RM24.50) and downgrade our call to MARKET PERFORM from OUTPERFORM.

Its 1QFY24 core net profit (excluding RM56m forex losses, RM18m disposal gains and RM62m fair value gains) disappointed, accounting for only 13% and 15% of our full-year forecast and the full-year consensus estimate, respectively. The variance against our forecast came largely from very poor downstream manufacturing performance which saw tight refining margins and oleo-chemicals margins despite QoQ improvement. Further drag to the already poor 1QFY24 earnings were soft earnings from its long-time Australian farming unit, and higher than usual tax rate. Net gearing inched up QoQ, from 53% to 56% due to acquisitions of two new estates and subscription for Synthomer’s rights issue. No dividend was declared for 1QFY24 which is the expected practice for KLK.

Better 2HFY24 likely. The global edible oil supply and demand balance is expected to stay tight in 2024 and potentially up till mid-2025 as inventories are set to dip below the levels in 2023. After the pandemic disruption, demand is back to 3%-4% YoY growth while supply is closely catching up. Relatively firm CPO price of RM3,800 per MT is thus expected which translate to RM3,400 for KLK over FY24-25. Production cost should stay mild as YoY fertiliser and fuel costs have trended lower by 30%-40%. However, downstream recovery is expected to stay muted. Recessionary concerns in Europe, inflation in US and subdued Chinese consumption coupled with over ordering in 2021-22 have dampened oleochemicals demand though some restocking is expected over the next 6-18 months.

Low key expansion. KLK has “quietly” added 8,610 ha of effective oil palm area since FY23 ended, indicating the group’s appetite and readiness to grow even if in gradual increments:

1. KLK bought 92% of PT Satu Sembilan Delapan (SSD) from parent Batu Kawan in Dec 2023. SSD has 5,384 Ha of oil palm near to KLK’s own 15k Ha in East Kalimantan.

2. Along with SSD, KLK also bought 90% of PT Tekukur Indah (TI) which owns 987 Ha of oil palm area also from Batu Kawan. As both SSD and TI were managed by KLK for Batu Kawan, moving forward, KLK will no longer recognise fee income but operating earnings instead.

3. KLK bought 95.43% in IJM Plantations and delisted it in Dec 2021. KLK is now in the process of buying the remaining 4.57% which it does not own. IJMP owns 76,183 Ha of land, 60,571 Ha of which are already planted.

Forecast. We cut our FY24-25F net profit forecasts by 23% and 16%, respectively, on poorer-than-expected downstream recovery. However, with net gearing expected to stay moderate, we continue to expect NDPS of 50.0 sen over FY24-25.

Valuations. Correspondingly, we reduce our TP by 6% to RM23.00 (from RM24.50) on rolled-forward 16x FY25F PER (from FY24), in line with the sector’s average. A 5% premium for its 4-star ESG rating as appraised by us is also imputed into the TP (see Page 3).

Investment case. Given its excellent track record, defensive balance sheet and expansionary mode, KLK’s investment case remains healthy but current downstream weakness may divert investors towards pure upstream albeit smaller players in the meantime. Downgrade to MARKET PERFORM from OUTPERFORM.

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

Source: Kenanga Research - 21 Feb 2024

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