HIGHEST RETURN ON EQUITY OVER THREE YEARS: Plantation: Kuala Lumpur Kepong Bhd - Exceptional returns from a leading planter

This article first appeared in The Edge Malaysia Weekly, on December 17, 2018 - December 23, 2018.
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Plantation giant Kuala Lumpur Kepong Bhd (KLK) walked away with the award for highest return on equity (ROE) over three years for the plantation sector for a second straight year at The Edge BRC awards.

KLK’s return on shareholders’ equity was 9% in the financial year ended Sept 30, 2015 (FY2015), 15.2% in FY2016 and 8.7% in FY2017. However, it should be noted that the group’s ROE in FY2017 — which slipped back to single digit — was its lowest in the past five years. The ratio, which measures how well a company uses shareholders’ funds to generate profit, stood at 12.2% in FY2013 and 12.8% in FY2014 respectively.

In KLK’s 2017 annual report, CEO Tan Sri Lee Oi Hian acknowledged that the group recorded lower returns on shareholders’ equity and total assets in FY2017 as the profits attributable to shareholders in FY2016 had taken into account the surplus from the sale of estate land and the net deferred tax benefit from the revaluation of its biological assets in Indonesia, totalling RM699.6 million.

It is also worth noting that shareholders’ equity has increased steadily over the last five years from RM7.53 billion in FY2013 to RM11.57 billion in FY2017.

Going forward, some analysts expect KLK’s ROE, which fell further to about 6% in FY2018, to remain low at single digits for at least the next two years.

PublicInvest Research analyst Chong Hoe Leong estimates KLK’s ROE will recover slightly to 8.2% in FY2019, 8% in FY2020, and 7.6% in FY2021. The current weak crude palm oil (CPO) prices remain a key challenge for the plantation segment in FY2019.

Similarly, BIMB Securities analyst Noorhayati Maamor forecasts KLK’s ROE to remain at 8.1% and 8.3% in FY2019 and FY2020 respectively. Given the current prospects for prices of palm oil products, BIMB Securities tweaked its earnings forecast lower for FY2019 and FY2020 to RM1 billion and RM1.06 billion respectively, from RM1.18 billion and RM1.22 billion previously.

MIDF Research analyst Alan Lim, for one, is of the view that KLK’s ROE could rebound to double digits to 10.5% in FY2019 and 11.9% in FY2020. Lim, who recently downgraded KLK to “neutral” with a target price of RM24.50, says the stock’s upside is likely to be capped due to short-term uncertainty over its dividend. However, the share price should be supported by the company’s strong balance sheet.

In any case, KLK outperformed its peers using the methodology for The Edge-BRC awards, where three-year ROE is weighted and adjusted to take into consideration how it is harder for larger companies to generate more profit than smaller ones.

Starting out as a plantation company more than a century ago, oil palm and rubber remain KLK’s core business activity. The group’s plantation land bank now stands at close to 270,000ha, extending across Peninsular Malaysia and Sabah; Belitung Island in Sumatra, and Central and East Kalimantan, Indonesia; and Liberia. Since the 1990s, KLK has diversified into resource-based manufacturing, including oleochemicals, derivatives and specialty chemicals, and thus vertically integrated its upstream and downstream businesses. The group also capitalised on the strategic location of its land bank in the peninsular by expanding into property development.

In FY2017, KLK delivered just over RM21 billion in revenue, an increase of 27% on the back of improved selling prices of products in the plantation sector and the oleochemicals business, as well as an increase in transactions of refined products by its trading arm. Its plantation sector registered a profit of RM1.29 billion, a sterling improvement of 56% from FY2016. This was mainly due to higher prices of palm commodity products.

The outlook is less sanguine, at least for the first half of next year, because of the prevailing depressed prices for palm oil products. “The current high CPO inventory level has impacted negatively on palm product prices. Whilst we expect FFB (fresh fruit bunches) production to improve, the current uncertainty in palm product prices will pose a challenge to our plantation profit for financial year 2019,” KLK said in the notes accompanying its 4QFY2018 results. It added that its oleochemical division “is expected to maintain its performance with higher capacity utilisation and operational efficiencies”.

If prices turn out to be better than expected, KLK may have a chance of scoring a hat trick next year.