Kuala Lumpur Kepong Bhd (KLK)
(Jan 9, RM22.16)
Maintain market perform with a target price (TP) of RM21.50: Kuala Lumpur Kepong (KLK)  announced that it had entered into a share purchase agreement (SPA) with Mitsui & Co Ltd (Mitsui) to dispose of a 20% stake in its wholly-owned subsidiary KLK Premier Capital Ltd (KLKPCL) for US$44 million (RM156 million).

KLKPCL owns a 100% equity interest in Taiko Palm-Oleo (Zhangjiagang) Co Ltd (TPOZ), a company incorporated in Jiangsu Province, China. Its principal activities are the manufacturing and trading of fatty acids, glycerine, soap, noodles and triacetin.

The proposed disposal is conditional on the injection of US$50.3 million by KLK or KLKPCL into TPOZ to fund the latter’s expansion of plant capacity and product range.

Additionally, KLK will maintain management of KLKPCL and TPOZ, while Mitsui is to promote the sale of TPOZ’s products to Japanese companies operating in China and assist in transferring related technology from Japan and other countries to TPOZ.

We are short-term “neutral” on the deal as we gather there is no earnings impact on financial year 2015 (FY15) to FY16 earnings since the proposed disposal will be accounted for as an equity transaction.

According to Malaysian Accounting Standards FRS127, an equity transaction is recorded when there is a change in ownership of subsidiaries (in KLK’s case from 100% to 80% ownership of KLKPCL) without loss of control.

However, we are long-term “positive” on this transaction due to the expansion of TPOZ’s plants and products.

KLK should also benefit from Mitsui’s existing client base in China and technical expertise in downstream businesses.

While we are long-term “positive” on the deal, the short-term outlook for the manufacturing division remains challenging due to rising capacity in the industry (especially in Indonesia).

The plantation division outlook is “neutral” as current crude palm oil (CPO) price is still below RM2,400 per tonne hence earnings are likely to be flat at best.

Maintain FY15 to FY16 earnings of RM1.09 billion to RM1.065 billion.

We expect limited share price upside due to flattish earnings growth of 6% seen in FY15. However, the downside is also limited due to KLK status as big cap planters and its syariah status, which encouraged syariah funds to hold this stock.

Maintain our TP of RM21.50 based on 21 times price-earnings ratio (PER) on FY15 earnings of RM1.02. Our target PER of 21 times reflects three-year historical PER average.

Risks are lower-than-expected CPO prices and lower-than-expected margin for downstream division. — Kenanga Investment Bank Bhd, Jan 9.

This article first appeared in The Edge Financial Daily, on January 12, 2015.