With  the  seasonal  peak  for  FFB  production  almost  over,  CPO  prices have  a  window  of  opportunity  to  strengthen  between  now  and  1Q15. This would bode well for a company like KLK, where we estimate every MYR100/tonne change in CPO prices could affect its earnings by 4-6% per  annum.  We  raise  our  SOP-based  TP to MYR21.30  (7.3%  downside) from MYR19.80 and upgrade the stock to NEUTRAL.   
 
Key  visit  highlights:  i)  Strong  recovery  in  FFB  production  in  4QFY14 (Sep), ii)  new  planting  is  slowing, iii)  its oleochemical  division  is  seeing margins  decline,  iv)  refining  margins  are  also  thinning  with  competitive pressures, and v) property launches will be more aggressive in FY15.   

Strong  recovery  in  FFB  production  in  4QFY14.  In  FY14,  Kuala Lumpur Kepong’s (KLK) FFB production rose 3.5%, which is higher than our originally projected 1.4%. In 4QFY14, it recorded a strong recovery, as  FFB  production  grew  16%  QoQ  (from  3QFY14)  and  10%  YoY.  For FY15, it believes production will recover further to record growth of 5-8% YoY,  slightly  higher  than  our  4-5%  growth  projection. We  are  adjusting our  forecasts  to  reflect  the  actual  3.5%  FFB  growth  recorded  in  FY14, but leave our 4-5% growth projection intact for FY15.  

Downstream capacity expands but margins thin. Although its topline revenue is still holding up well, KLK’s downstream  division  has  been recording declining margins on the back of tougher operating conditions and  an  intensifying  competitive  environment.  From  a  high  of  9.2%  in 1QFY14, its olechemical manufacturing margin fell to 4.7% in 3QFY14. For 4QFY14, management highlighted that margins could potentially be weaker  than  3QFY14.  We  assume  that  its  oleochemical  margins  will average  5-6%  for  FY14  and  FY15.  KLK’s  oleochemical  capacity (Indonesia, Germany, Malaysia, Switzerland and China) is on track to hit 2.3m tonnes by FY15 (up from 1.7m tonnes in FY12).  

Upgrade to NEUTRAL. We raise our FY14-15 earnings forecasts by 3-4% and introduce our FY16 estimate. KLK’s share price has recovered from  its  recent  lows  of  slightly  below  MYR20.00.  We  believe  with  the seasonal peak season being almost over, CPO prices have a window of opportunity  to  strengthen  between  now  and  1Q15,  which  would  bode well  for  a  company  like  KLK,  where  we  estimate  every  MYR100/tonne change in CPO price would affect  its earnings by 4-6% per annum.  As such,  we  raise  our  SOP-based  TP to  MYR21.30  (from  MYR19.80)  and upgrade the stock to NEUTRAL (from Sell).

Key  highlights  from  our  recent  visit:  i)  Strong  recovery  in  FFB  production  in 4QFY14,  ii)  new  planting  is  slowing,  iii)  its  oleochemical  division  is  seeing  margins decline,  iv)  refining  margins  are  also  thinning  with  competitive  pressures,  and  v) property launches will be more aggressive in FY15.   

Strong  recovery  in  FFB  production  in  4QFY14.  In  FY14, KLK’s FFB production rose 3.5%, which is higher than our originally projected 1.4%. In 4QFY14, it recorded a  strong  recovery in yields,  as  FFB  production  grew  16% QoQ (from  3QFY14) and 10% YoY. Based on KLK’s FFB output, it looks like production has already peaked in August and is now on the way down. For FY15, KLK believes production will recover further to record growth of 5-8% YoY, slightly higher than our 4-5% growth projection. We  are  adjusting  our  forecasts  to  reflect  the  actual  3.5%  FFB  growth  recorded  in FY14, but leave our 4-5% growth estimate intact for FY15.  

New planting slowing. In FY14, KLK planted up about 3,000 ha of new landbank in Indonesia,  out  of  its  10-12k  ha  plantable  area  that  is  remaining.  Although  this  was short  of  its  5,000ha  target,  management  highlighted  the  increasing  difficulties  in planting up new landbank in this day and age, and is only targeting to plant up about 1,000ha  in  FY15.  We  have  adjusted  our  forecasts  to  take  these  changes  into account. Given this scenario, the company continues to look for acquisitions to grow its landbank.  At  this  juncture, it  is  no  longer looking to  expand  further  in  Indonesia, given  the  100,000ha  limit  ruling,  and  is  looking  at  other  suitable  countries.  New planting  at  its  25,547ha  landbank  in  Liberia  has  yet  to  start,  with  management  still working on rehabilitating the existing land which has been planted (3,570ha).

Margins  decline  at  its  oleochemical  division.  Although  topline  revenue  is  still holding  up  well,  KLK’s downstream division has  been  seeing  declining  margins  on the back of tougher operating conditions and an intensifying competitive environment. From  a  high  of  9.2% in 1QFY14, KLK’s olechemical  manufacturing  margin  fell  to 6.8% in 2QFY14 and subsequently to 4.7% in 3QFY14. For 4QFY14, management highlighted that margins could potentially be weaker than that of 3QFY14. We have assumed  its  oleochemical  margins  to  average  5-6%  for  FY14  and  FY15.  KLK’s oleochemical capacity (Indonesia, Germany, Malaysia, Switzerland and China) is on track  to  hit  2.3m  tonnes  by  FY15  (up  from  1.7m  tonnes  in  FY12).  Other  than  this, management has no plans to expand further, but is instead looking now at acquiring technology to widen its product range. 

Refining margins also thinning with competitive pressures. On the refining front, we  also  expect  margins  to  thin  further,  particularly  as  margins  in  Indonesia  are declining as  a  result  of increased  competition  on  the  back of  a  substantial  capacity expansion. We  understand refining margins in Malaysia are  already negative, while refining margins in Indonesia are still positive but on a declining trend. KLK has three relatively new refineries in Indonesia – one in Belitung, which was completed in 2013 (1,000 tonnes/day) and one in Mandau (600 tonnes/day, completed in end-2013) and Dumai (2,000 tonnes/day), which just started operations in mid-Sep 2014. Although the company does have a significant amount of landbank in Indonesia to service its refineries, it would still need to  acquire external FFB to boost its capacity utilisation, which is now getting more difficult because of the competition for CPO. 

Property  launches  to  be more  aggressive  in  FY15.  In  FY14,  KLK  launched  very few  new  property  projects,  resulting in  a 50%  decline  in revenue  in  9MFY14  and  a 45% decline in EBIT. Going into FY15, management intends to step up its property launches  in  Bandar  Seri  Coalfields,  its  sole  property  project  currently  and  aims  to launch projects worth MYR200-300m in GDV. Take-up rates at its existing launches have been holding up well at 60-70%, given  its mid-range target market.  Given this scenario, we have trimmed our forecasts for the property division for FY14 but raised our projections for FY15.   
 
Risks 
Main  risks.  Main risks  include: i) a  convincing reversal in the  crude  oil  price  trend, resulting  in  the  reversal of CPO and other vegetable oils’ price trends, 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 
Raising forecasts slightly. After raising our FFB production forecasts for FY14-16, reducing our new planting targets and adjusting our property division projections, we revised  our  FY14-15  earnings  forecasts  3-4%  higher,  and  introduce  our  FY16 numbers.  
 
Valuation and recommendation 
Upgrade  to  NEUTRAL.  KLK’s share price has recovered from its recent lows of slightly below MYR20.00. We believe with the peak season being almost over, CPO prices have a window of opportunity to strengthen between  now and 1Q15  – which would  bode  well  for  plantation  companies  like  KLK  with  decent  sensitivity  to  the fluctuations  in  the  price  of  CPO.  We  estimate  that  every  MYR100/tonne  change  in CPO price  would affect  KLK’s net earnings by 4-6% per annum.   As such, post our earnings  revision,  we  raise  our  SOP-based  TP  to  MYR21.30  (from  MYR19.80)  and upgrade the stock to NEUTRAL (from Sell). 

Financial Exhibits

Financial Exhibits

SWOT Analysis

Company Profile

Kuala Lumpur Kepong (KLK) is an integrated plantations company with palm oil plantations landbank in Malaysia, Indonesia and Papua New Guinea. The company also operates in the downstream manufacturing segment through its edible oil refineries and oleochemical businesses. It is also involved in property development. 

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Source: RHB