KLK benefitting from IOI Corp’s RSPO suspension

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This article first appeared in The Edge Financial Daily, on July 5, 2016.

 

Kuala Lumpur Kepong Bhd
(July 4, RM23.22)
Maintain buy with a lower target price (TP) of RM26.20:
Kuala Lumpur Kepong Bhd (KLK) remains our top pick in the plantation sector. Its geographically diverse land bank lends itself to milder effects from extreme climate conditions. Its timely move into refinery operations in Indonesia has also allowed it to benefit from the tax advantage over Malaysia. We maintain “buy” with a slightly lower sum-of-parts (SoP)-based RM26.20 TP (from RM26.30, 13% upside), implying an enterprise value (EV)/hectare (ha) of US$35,000 (RM139.832) per ha. This is in line with its peers, which trade at US$30,000 to US$40,000 per hectare.

Fresh fruit bunch (FFB) output is to improve in second half of financial year ending Sept 30, 2016 (2HFY16). KLK’s year-to-date May FFB output is down 4.5% year-on- year (y-o-y), impacted by the dry weather experienced in Sabah and Riau. 

For FY16, KLK expects to end the year with flat to marginally “positive” FFB output growth, as it expects to see a recovery in the last few months of its financial year. This is in line with our 1.5% FFB growth projection for FY16. For FY17, the company is maintaining its guidance of a small single-digit growth in FFB, which is in line with our 2.5% growth projection. Benefitting from IOI Corp Bhd’s roundtable on sustainable palm oil (RSPO) suspension: KLK managed to do some forward sales in first quarter(1Q), albeit not a significant amount — 25% to 30% of 1Q’s output. Its internal budget for crude palm oil (CPO) prices for FY16 is between RM2,200 and RM2,400 per tonne. However, it is currently benefitting from the sale of more certified sustainable palm oil (CSPO) products as a result of IOI Corp’s (“neutral”, TP: RM4.35) suspension from RSPO. Currently, close to 50% of its products (from 30%) are sold with a CSPO premium. The premium has also risen to about US$35 to US$40 per tonne (from US$20 to US$25 per tonne). It currently produces about 750,000 tonnes of RSPO-certified oil, of which 70% is fully segregated and 30% is mass balance.

Reducing earnings forecasts by 1% to 9%: After reducing our property division profits, adjusting our capital expenditure assumptions and reducing our new planting targets, we reduced our FY16 to FY18 earnings forecasts down by 1% to 9% per annum. A key downside risk is the weather abnormalities.

We maintain “buy” with a lower SoP-based TP of RM26.20, which implies an EV/ha of US$35,000. This is within the range of its big-cap peers of US$30,000 to US$40,000. We like KLK as its more geographically diversified land bank reduces the risk in extreme weather situations, while its downstream facilities continue to record improving margins. We also highlight that every RM100 per tonne change in CPO prices could affect KLK’s net profit by 4% to 6% per annum. —RHB Research Institute, July 4