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Kuala Lumpur Kepong Bhd
(Oct 31, RM23)
Upgrade to neutral from sell with increased target price of RM21.30 from RM19.80:
With the seasonal peak for fresh fruit bunch (FFB) production almost over, crude palm oil (CPO) prices have a window of opportunity to strengthen between now and the first quarter of 2015 (1Q15).

This would bode well for a company like KLK, for which we estimate every RM100 per tonne change in CPO price could affect its earnings by 4% to 6% per year.

We raise our sum-of parts-based target price (TP) to RM21.30 (7.3% downside) from RM19.80 and upgrade the stock to “neutral”.

Key highlights are: (i) strong recovery in FFB production in 4Q ended September of financial year 2014 (FY14); (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.

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, as FFB production grew 16% quarter-on-quarter (q-o-q) and 10% year-on-year (y-o-y).

For FY15, it believes production will recover further to record growth of 5% to 8% y-o-y, slightly higher than our 4% to 5% growth projection.

We are adjusting our forecasts to reflect the actual 3.5% FFB growth recorded in FY14, but leave our 4% to 5% growth projection intact for FY15.

Although its top-line 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 3Q. For 4QFY14, management highlighted that margins could be weaker than 3Q. We assume that its oleochemical margins will average 5% to 6% for FY14 and FY15.

KLK’s oleochemical capacity (Indonesia, Germany, Malaysia, Switzerland and China) is on track to hit 2.3 million tonnes by FY15, up from 1.7 million 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.

In FY14, KLK planted up about 3,000ha of new land bank in Indonesia, out of its 10,000ha to 12,000ha of plantable area that is remaining.

Although this was short of its 5,000ha target, management highlighted the increasing difficulties in planting up new land bank 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 land bank.

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 land bank in Liberia has yet to start, with management still working on rehabilitating the existing land which has been planted (3,570ha).

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 per day) and one in Mandau (600 tonnes per day, completed in end-2013) and Dumai (2,000 tonnes per day), which just started operations in mid-September 2014.

Although the company does have a significant amount of land bank 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.

In FY14, KLK launched very few new property projects, resulting in a 50% decline in revenue in the nine months (9M) of FY14 and a 45% decline in earnings before interest and taxes (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 RM200 million to RM300 million in gross development value (GDV).

Take-up rates at its existing launches have been holding up well at 60% to 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.

Main risks include: (i) a convincing reversal in the crude oil price trend, resulting in the reversal of the price trends of CPO and other vegetable oils; (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.

After raising our FFB production forecasts for FY14 to FY16, reducing our new planting targets and adjusting our property division projections, we raise our FY14/FY15 earnings forecasts by 3% to 4% and introduce our FY16 estimates.

KLK’s share price has recovered from its recent lows of slightly below RM20. — RHB Research Institute, Oct 31

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This article first appeared in The Edge Financial Daily, on November 3, 2014.

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