• Maintain BUY, with new TP of MYR25.80 from MYR27.00, 18% upside and c.3% FY24F (Sep) yield. Kuala Lumpur Kepong (KLK) is among the companies that are well placed to comply with the European Union (EU) Deforestation Regulation (EUDR). Valuation is inexpensive, trading at 17.4x, at the lower end of its peer range of 16-20x.

• The EUDR is not unsurmountable. While there are a myriad of problems and issues in complying with the EUDR guidelines based on current regulations, we believe there are also numerous solutions. The Malaysian and Indonesian Governments working together with the EU to find solutions is a step in the right direction – especially if Malaysia and Indonesia are classified as “Low Risk”. Aligning definitions are key to achieving compliance and ensuring everyone is on the same page.

• The EU needs to help, otherwise this problem will be shifted elsewhere. At the end of the day, if the EU fails to help producing countries like Indonesia and Malaysia in complying with the EUDR, it will push producers to export more of their commodities to countries with weaker environmental regulations, thereby shifting the problem to other regions.

• A short term solution would be to ensure that whatever is sold to the EU is produced in segregated mills and refineries and traceable to plantation. This could mean redirecting smallholder crops which are not traceable to other mills to ensure there is no mixing of crops in each plant.

• Uplifting smallholders means uplifting the sector. As smallholders manage 40% of plantation areas in Indonesia and Malaysia, this sector will only progress if they are taken care of and well updated with the changes in laws and regulations. As discussed previously, the main hurdle of achieving traceability lies with obtaining data from third-party suppliers, including smallholders. In order to address this, continuous engagement with the smallholders is essential to educate them on the importance of establishing a sustainable business, while the necessary tools must be given to the smallholders to help them to achieve these goals.

• We believe the sector in general is moving in the right direction in terms of ESG standards, with more disclosure and targets being set. However, we note that there are some outliers which have yet to make any improvements to ESG disclosures as well as ESG targets.

• We raise our ESG score to 3.0 (from 2.8) after lifting its score for the “Environment” pillar, as KLK has managed to improve its GHG emission intensity, water and energy consumption as well as traceability to plantation.

• Maintain BUY, with a lower MYR25.80 TP, after revising its earnings down by 7-19% as we now resume coverage of this counter. We believe KLK is well placed to adhere to the EUDR, while valuation remains attractive – currently trading at 17.4x, at the lower end of its peer range of 16-20x. 

Source: RHB Securities Research - 21 Nov 2023