CIMB Research has raised its target price (TP) for Kuala Lumpur Kepong Bhd (KLK) to RM10.20 from RM9.70 for a lower sum-of-parts (SOP) discount of 5% instead of 10% given the improved risk appetite in the market and its recent narrowing of SOP discount for its peer, Sime Darby Bhd.

“But the stock remains an underperform due to its unattractive valuations and a potential drop in CPO (crude palm oil) price from the current level due to higher production in the third quarter,” it said in a research note yesterday.

CIMB maintained its earnings numbers on KLK as the anticipated improvement in plantation earnings in the second half of this year would be tempered by weaker contributions from the manufacturing and retail divisions.

KLK revealed that it expected the plantation division to perform reasonably well this year due to forward sales.

“However, its manufacturing profit has come under pressure due to the global economic downturn, which has also hurt the retail division,” said CIMB. “Management plans to address this issue by restructuring the retail operations.”

The research house said key de-rating catalysts were lower CPO and crude oil prices. It preferred Wilmar International Ltd and Sime Darby for exposure to the plantation sector.

Meanwhile, OSK Research said it was fond of KLK for its double-digit production growth, made possible by the hive of planting activities in the past few years.

The research house said although production for the March quarter trailed last year’s level, April production growth indicated that it was recovering.

“KLK’s production growth momentum will likely be maintained given the company’s still-young age profile,” it said. “Still, given our negative outlook for CPO price, especially in the second half, we believe its stock price could weaken.”

OSK maintained sell on the company with a target price of RM9.95.

“KLK’s annualised first half of FY09 (fiscal year ending Sept 30, 2009) core earnings came in 17.2% below our forecast and 5.6% below consensus,” it said. “We expect second half of FY09 to be stronger and make up for the first half’s weakness.”

Hence, there is no change in OSK’s forecast. KLK’s core net profit for the quarter fell by 49.9% quarter-on-quarter as plantation segment earnings before interest and taxes (Ebit) fell by 34.7% on lower CPO prices and a 13.5% decline in production.

KLK’s downstream business turned in profit of RM5.8 million after an inventory writeoff dragged the segment into a loss last quarter, according to OSK.
 
“Margin, however, remained razor-thin, at just 1.0%,” said the research house. “On the other hand, the retailing segment lost RM39.5 million against RM30.5 million profit in the December quarter.”

Nevertheless, OSK said KLK’s balance sheet remained strong. Its net borrowings stood at RM576 million translating into a net gearing of 11.2%. The company generated RM626.7 million in operating cash in the first half, up significantly from RM278.2 million in the same period last year.

KLK dropped 40 sen to close at RM11.50 yesterday.

This article appeared in The Edge Financial Daily, May 29, 2009.