There is not much positive news from KLK, other than the upcoming expansion at its refinery and oleochemical divisions, which would help drive revenue and bottomline growth going forward. We expect improved margins from the downstream manufacturing unit to help offset lower CPO prices at its upstream plantation division. Maintain NEUTRAL, with its SOP-based FV trimmed to MYR20.60.

• Key points from our company visit: i) Kuala Lumpur Kepong (KLK)’sFFB production is expected to grow by 10-15% in FY13, ii) the view on CPO prices is now more neutral, iii) production costs increased in 3QFY13 due to Indonesian mill issues, iv) new planting in FY13 will be slow and planting plans will be delayed in Papua New Guinea, v) refinery and oleochemical expansion is facing some delays, and vi) the company is lowering capex targets for FY13.
• Forecasts revised slightly. All in, we are trimming our forecasts by 3-4% for FY13-14, after taking the following into account: i) the delays in completion of its refineries and oleochemical plants, ii) the slower progress of its new planting, and iii) its lower capex assumption for FY13.
• Main risks. Main risks include: i) a convincing reversal in the crude oil price trend triggering a reversal of CPO’s and other vegetable oils’ price trends, ii) abnormalities in weather that result in an over- or undersupply of vegetable oils, iii) a revision in global biofuel mandates and trans-fat policies, and iv) a slower-than-expected global economic recovery, resulting in weaker-than-expected demand for vegetable oils.
• Decent company, but rich valuations. Although KLK remains a solid, well-focused plantation company, we believe its valuations are too rich. Its existing and soon-to-be expanded downstream facilities which will come on-stream over the next two years would help mitigate the effect of lower CPO prices on its upstream business. Its Indonesia refineries will also benefit from an upswing in CPO price due to Indonesia’s export tax structure. Post-earnings revision, our SOP-based FV has been lowered slightly to MYR20.60 (from MYR21.00). Maintain NEUTRAL.

Key highlights
Key points from our company visit: i) FFB production is expected to grow by 10-15% in FY13, ii) the view on CPO prices is now more neutral, iii) production costs increased in 3QFY13 due to Indonesian mill issues, iv) new planting in FY13 will be slow and planting plans will be delayed in Papua New Guinea, v) refinery and oleochemical expansion is facing some delays, and vi) it is lowering capex targets for FY13.

Decent production growth. In YTD Aug FY13, KLK recorded a 12.9% y-o-y growth in FFB production, in line with its guidance of 10-15% for the year. Its production saw a significant seasonal uptick in July (+19.7% m-o-m), followed by a smaller +8.1% m-o-m growth in August (due to the festive season). It expects this growth to continue for the next few months before peaking in October. We are maintaining our FFB growth forecasts at 14.3% for FY13 and 5.6% for FY14.

CPO price view more neutral now. Management’s earlier bearish view on CPO prices – in which it expected CPO prices to trend down to MYR2,200/tonne – had been validated. It now believes CPO prices to remain range-bound at MYR2,250-2,400/tonne for the next six months. For FY13, management expects CPO prices to average around MYR2,300/tonne (9MFY13: MYR2,268/tonne).

3QFY13 production costs higher due to Indonesian mill issues. In 9MFY13, KLK’s unit production cost was about MYR1,300/tonne, up from about MYR1,200/tonne in 1HFY13. This was attributed to higher unit costs at its Indonesian operations in 3QFY13, caused by lower FFB yields and some operational issues at a mill. These issues have since been ironed out, but management now expects FY13 average unit production costs to remain flat y-o-y at around MYR1,300/tonne. This is an increase from its previously guided 5-10% y-o-y decline in FY13 unit production cost, but in line with our projections. Going forward, we estimate production costs to increase by 5-10% y-o-y in FY14 due to higher labour and transport costs.

Slow new planting progress in FY13 and delays in planting plans for PNG. As at end-FY12, KLK had about 23,390ha of plantable reserves in East Kalimantan and Sumatra, which it originally intended to plant up at a rate of 5,000-8,000ha per year. However, up to 9MFY13, the company had only planted up less than 1,000ha of land, due to slow regulatory approvals and skilled labour shortages. As a result, KLK is likely to only plant up about 2,000ha of land in FY13, although it hopes to achieve its new planting targets in the coming years. Note that there is no progress yet at its Papua New Guinea (44,342ha) landbank. The company is still in the midst of conducting the required social and environmental studies and expects new planting to only start in 1QCY2014, instead of end-CY2013 as originally planned. We are adjusting our new planting projections downwards to 2,000ha (from 8,000ha) for FY13 and to 5,000ha (from 8,000ha) for FY14.

Refinery expansion facing some delays. KLK’s downstream expansion is on track, with the first of its three Indonesian refineries in Belitung (1,000 tonnes/day) already up and running since end-April. Although there have been some teething issues with the refinery, which resulted in some minimal startup losses in 3QFY13, management expects these issues to be sorted out by 4QFY13, targeting the plant to turn around by then. Management is targeting to ramp up capacity utilisation for this plant to more optimal levels by mid-CY14. As for its two other refineries in Dumai (2,000 tonnes/day) and Mandau (1,600 tonnes/day), there have been some delays in the construction of these plants due to shortages of skilled labour and the importation of parts, which have pushed the completion date to 1QCY2014 (from end-CY13). The Mandau plant is likely to be ready first, followed by the Dumai facility. Therefore, we have pushed back the completion date of these plants in our forecasts accordingly. We continue to be wary of the prospects of KLK’s aggressive refinery expansion in Indonesia, given the intensifying competition for CPO feedstock going forward, as many new refinery capacities are expected to come onstream in Indonesia over the next 1-2 years. Note that we have imputed very low utilisation rates of 50% and below for the initial years. Nevertheless, in the event of an upswing in CPO price, these refineries will allow KLK to be remain very competitive given the nature of export duty structure in Indonesia, which gives refiners a competitive edge at higher CPO price levels against Malaysian refiners.

Oleochemical expansion also slightly delayed. As for KLK’s oleochemical expansions, completion of the 150,000 tonne p.a. facility in Dumai, Indonesia will be delayed to 1QCY14 (from end-Sept 2013), while completion of its facility expansion in Germany and Malaysia have also been delayed to end-CY13 (from end-Sept 2013). KLK’s 200,000-tonne expansion of its Zhangjiagang, China-based oleochemical plant, however, was completed in June 2013, and is already in operation. All in, KLK expects a total of 500,000 tonnes of new oleochemical capacity to be up and running by FY15, increasing KLK’s total annual oleochemical capacity by 30% to 2.18m tonnes. We have adjusted our forecasts to account for the delays in completion. We are more positive on the prospects of KLK’s oleochemical division at this juncture, given the low CPO feedstock price environment, which has resulted in EBIT margins for this division rising to 6.6% in 9MFY13 (from 3.8% in 9MFY12). We project EBIT margins to remain in the 6-7% range for the rest of FY13 and FY14.

Cutting FY13 capex budget. The company has cut its capex budget to MYR0.9bn from MYR1.3bn, due to lower new planting expected in FY13. We are lowering our FY13 capex projections accordingly, but leave our MYR800m projection for FY14. We highlight that KLK would have no problems funding its capex expansion, given its recent MYR1bn Islamic medium-term notes issuance. At last count (end-3QFY13), KLK’s net debt was only MYR503m, implying a net gearing of 7%. We expect its net gearing to remain below 10% for the next few years.
Risks

Main risks. Main risks include: i) a convincing reversal in the crude oil price trend, resulting in the reversal of CPO’s and other vegetable oils’ price trend, ii) weather abnormalities resulting in an over- or undersupply of vegetable oils, iii) a revision in global biofuel mandates and trans-fat policies, and iv) a slower-than-expected global economic recovery, resulting in lower-than-expected demand for vegetable oils.
Forecasts

Revised down slightly. All in, we are revising our forecasts downwards by 3-4% for FY13-14, after taking into account: i) delays in the completion of its refineries and oleochemical plants, ii) slower new planting progress, and iii) lower capex assumption for FY13.

Valuation and recommendation
Maintain NEUTRAL. Although KLK remains a solid, well-focused plantation company, its valuations are too rich, in our opinion. The company’s existing and soon-to-be expanded downstream facilities expected to come onstream over the next year or two would help mitigate the effect of lower CPO prices on its upstream business. Post-earnings revision, our SOP-based valuation has been lowered slightly to MYR20.60 (from MYR21.00). We make no changes to our NEUTRAL recommendation.

Source: RHB