KLK expected to see strong gains from higher CPO price

Kuala Lumpur Kepong Bhd
(Jan 7, RM24.94)
Maintain outperform with a higher target price (TP) of RM28.11:Kuala Lumpur Kepong Bhd (KLK) is set for strong gains from the upstream plantation business on stronger crude palm oil (CPO) price. We reckoned it will have one of the most commendable margins in the industry driven by its cost efficiency and a steady fresh fruit bunch (FFB) production growth.

However, the manufacturing segment could suffer from margin pressure owing to a higher feedstock cost and stiffer competition from other substitutes. Nevertheless, its downstream segment only accounts for 10% of earnings forecasts for financial year 2020 (FY20F). We roll over our valuations to FY21F with a higher TP of RM28.11 after raising our FY20F to FY22F earnings by 10% to 13%, after lowering our projections on costs and raising our annual FFB production growth to 5%. Our “outperform” call is maintained.

The management guided that it completed its fertiliser application target over the last one year despite a tough CPO price performance. For FY20F, KLK is expected to see a stronger FFB production growth of 5% year-on-year (y-o-y), versus FY19’s 4.4%, to about 4.3 million tonnes.

Its mature areas were at 181,083ha as of end-FY19, with an additional new mature areas of 5,000ha this year. A total of 11,000ha was replanted last year with the main areas covering Lahad Datu, Peninsular Malaysia, Belitung Island and North Sumatra. KLK’s plantation age remains at 12.4 years old with a total planted area of 213,377ha.

Its cost of production in FY19 rose 6% y-o-y to RM1,456 per tonne excluding palm kernel contribution, due to the minimum wage hike’s impact in Malaysia (+9%) and Indonesia (5% to 7%). The management expects a flat to slight increase in the cost of production this year likely due to similar reasons. It has locked in nearly 50% of its FY20 budget for fertiliser application at a steady level.

The management has allocated a higher capital expenditure of RM700 million for FY20, versus RM644 million spent in FY19, with the plantation segment taking up 57% or RM400 million, mainly used for replanting covering 14,000ha.

Two of KLK’s core businesses are upstream plantation and manufacturing segments. However, the two independently run segments see mixed fortunes when CPO price rises. Driven by stronger FFB production and increased CPO price to above RM3,000 per tonne, we believe KLK’s plantation bottom line could surpass our earnings forecasts given our full-year CPO price assumption of only RM2,600 per tonne.

Based on our sensitivity analysis, for every RM100 per tonne increase in CPO price, KLK’s bottom line is estimated to rise 13% to 15% or about RM100 million. However, KLK’s oleochemical business could suffer from a further margin squeeze in view of significantly higher feedstock price, overcapacity and preferential European Union duty exemption for Indonesian counterparts. —PublicInvest Research, Jan 7