KL Kepong - Stronger growth ahead

Strong earnings momentum in 2HFY09 coming from plantation business. Contribution from plantation (85-90% of pre-tax profit) will pick up substantially in 2HFY09, supported by:

a) Higher production from Indonesia estates. Production is likely to be supported by stronger production in 2HFY09. Despite the 4% FFB production drop in 1HFY09, we expect production to grow 7-8% yoy for FY09, i.e., expecting mid-teens growth for 2HFY09. It is an industry norm to have a production ratio of 45:55 for the both halves of the year.

b) Stronger ASP. KLK has been selling mainly on the spot market now. Thus, it will benefit from current high CPO prices of RM2,400-2,600/tonne. In 1HFY09, ASP was RM2,200/tonne vs industry of about RM1,700.

c) Positive contribution from manufacturing. We project a small profit of RM90m (-23% yoy) in FY09, a turnaround from a RM4m loss in FY08. Downstream business was hit by inventory write-offs and defaults in China, but the worst is over with stock level dropping from the peak of 45,000 tonnes to 30,000 tonnes. Malaysia’s operation is still making money with a margin of 3-4%.

d) Retail will be in the red with losses in the US and Europe markets, as they are hit hardest by the financial crisis and recession. We are even more bullish on KLK’s FY10 performance, backed by the strong performance from the plantation division. It will a bonus to come if the new management team is able to turn Crabtree & Evelyn around.

Strong production growth coming from high young and immature areas. From FY10, KLK is likely to report a 10% fresh fruits bunch (FFB) production growth for at least three consecutive years, with the strong newly mature acreage coming onstream and young areas making up a total of 48.2% of planted areas.

Management change for Crabtree & Evelyn. There is a change in management recently to make it more Asia-centric. As Asia has been the profit centre for Crabtree & Evelyn, it makes sense to let an Asian team to drive the business growth strategy. Management expects breakeven by end- 09 (1HFY09: a loss of RM8.9m) and should be able to report a small profit for FY10. This business will be kept for the next 2-3 years and it fails to turn around, it could be disposed.

No change to our earnings forecasts. Potential earnings upgrade for FY10 onwards from strong FFB production. Earnings risk increases if CPO price falls.

Maintain BUY. We forecast core net profit of RM867.1m (EPS: 81.2 sen) and RM1,007.2m (EPS: 94.3sen) for FY09 and FY10 respectively. KLK is our top pick for Malaysia-listed companies. It is the best big-cap pure play on rising CPO prices and for the strong production growth coming onstream. We raise our target price to RM14.00 based on 15x FY10F PE, in line with the rising PE multiples for big-cap peers.