KL KEPONG BUY. Young trees to underpin long-term growth. Company report. (Maintained) Rationale for report: Company Update PLANTATION

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1 PLANTATION KL KEPONG (KLK MK, KLKK.KL) 20 March 2013 Company report Gan Huey Ling, CFA Young trees to underpin long-term growth Rationale for report: Company Update BUY (Maintained) Price Fair Value 52-week High/Low Key Changes Fair value EPS RM20.54 RM23.15 RM24.90/RM17.00 Unchanged YE to Sep FY12 FY13F FY14F FY15F Revenue (RMmil) 10, , , ,106.0 Net Profit (RMmil) 1, , , ,438.1 EPS (sen) EPS growth (%) (22.9) (1.0) Consensus net (RMmil) 1, , ,452.0 DPS (sen) PE (x) EV/EBITDA (x) Div yield (%) ROE (%) Net gearing (%) Stock and Financial Data Shares Outstanding (million) 1,067.5 Market Cap (RM mil) 21,926.5 Book value (RM/share) 6.66 P/BV (x) 3.1 ROE (%) 17.1 Net Gearing (%) 1.7 Major Shareholders Batu Kawan Bhd (47%) EPF (14%) Free Float (%) 53 Avg Daily Value (RMmil) 20.2 Price performance 3mth 6mth 12mth Absolute (%) Relative (%) Investment Highlights Maintain BUY on Kuala Lumpur Kepong Bhd (KLK) with an unchanged fair value of RM23.15/share. On the back of a recovery in FFB yields, we forecast KLK s FFB production to expand by 13% in FY13F after a 1% decline in FY12. KLK s strength lies in the young age of its oil palm trees as reflected in the average age of years old. Most of the group s young trees are in Indonesia, accounting for 51% of planted areas. We estimate that Indonesia accounts for more than 40% of the group s FFB production. We also understand that the group s operations in Lahad Datu, Sabah have not been affected by the crisis. KLK s refinery and harvesting operations are still running. About 7.7% of KLK s landbank is in Lahad Datu. Approximately 23% of the group s mature areas are in Sabah. Manufacturing profits are envisaged to improve by 37% in FY13F after a decline of 17% in FY12, dragged by poor margins and demand. We have not accounted for earnings contributions from KLK s new refineries in Indonesia in our earnings forecasts. Based on a conservative pre-tax refining profit margin of US$10/tonne (RM31/tonne), we estimate that the three refineries in Indonesia could contribute RM39mil or 3% in earnings to KLK. The bulk of the earnings would come in FY14F when all three refineries are up-and-running. KLK s refinery in Belitung is expected to commence operations in the next few months, while the remaining two in Sumatra are targeted for commissioning by year-end. All in, KLK s refineries in Indonesia are envisaged to command a capacity of 1.26mil tonnes/year or 3,600 tonnes/day when they are fully operational. The costs of the refineries are estimated at RM150mil in total. A key risk would be a glut in refining capacity in Indonesia. According to an industry expert, refining capacity in the country is estimated to climb from 25mil tonnes in 2012 to 30mil tonnes in 2013F. In comparison, Indonesia s CPO production is forecast at 29mil to 30mil tonnes for 2013F. We forecast a dividend yield of 3% to 4% for KLK in FY13F. Gross dividend is anticipated to rise from 65 sen/share in FY12 to 68 sen/share in FY13F. Balance sheet is expected to remain healthy, in spite of a small increase in net gearing from 1.7% in FY12 to 9.7% in FY13F. PP12247/06/2013(032380)

2 CHART 1 : AGE PROFILE OF OIL PALM TREES IN INDONESIA AS AT END-MARCH 2012 Source: Company MAINTAIN BUY WITH UNCHANGED FAIR VALUE OF RM23.15/SHARE We are keeping our BUY recommendation on Kuala Lumpur Kepong Bhd (KLK), with an unchanged fair value of RM23.15/share. We have reduced KLK s FY13F earnings forecast by 3.8% to account for lower plantation operating margins. KLK s strength lies in the young age profile of its oil palm trees. This is envisaged to expand FFB yields as more trees enter the prime age of eight to 15 years. KLK s manufacturing profits are forecast to improve by 37% in FY13F after falling 17% in FY12, dragged by poor margins and competition from Indonesian producers. A key risk is a glut of refining capacity in Indonesia. Two of KLK s refineries are expected to start operations by yearend. It is estimated that the installed refining capacity in Indonesia would reach 30mil tonnes in 2013F vs. 25mil tonnes last year. expected to be underpinned by an increase in the volume of palm oil production and weaker fertiliser cost. We reckon that production cost would either edge down or remain flat at the RM1,300/tonne level in FY13F. We have forecast KLK s FFB production to grow by 13% in FY13F versus a 1% decline in FY12. Improvements in FFB production are anticipated to be supported by a recovery in yield and an increase in mature areas. We estimate Indonesia to account for more than 40% of KLK s FFB production. About 51% of KLK s planted areas are located in Indonesia. As mentioned earlier, the average age of KLK s oil palm trees in Indonesia is eight years old. Roughly 34% of the oil palm trees in Indonesia are between four and nine years old while another 34% are aged 10 to 18 years (see Chart 1). KLK s balance sheet is healthy. The group s net gearing declined from 5.9% as at end-sept 2011 to 1.7% as at end-sept The increase in cash reserves was partly due to the sale of Crabtree & Evelyn for US$155mil or RM455mil. OPERATIONAL UPDATES Plantation division to benefit from flat or lower production cost per tonne in FY13F The plantation division is envisaged to benefit from a stable production cost per tonne in FY13F. This is AmResearch Sdn Bhd 2

3 TABLE 1: EXPOSURE TO LAHAD DATU AND SABAH Hectarage in Lahad Datu Total landbank (including rubber) % of landbank in Lahad Datu Hap Seng Plant 36,354 39, % KLK 19, , % IOI 48, , % TH Plant 5,906 91, % Kulim Gent Plant TSH IJM Plant Size of mature landbank in Sabah Total mature landbank % of total mature landbank Hap Seng Plant 31,068 31, % KLK 35, , % IOI 97, , % TH Plant 9,930 40, % Kulim - 35, % Gent Plant 39,002 63, % TSH 4,380 18, % IJM Plant 24,537 26, % Source: Companies, AmResearch An additional 27% of the trees are less than four years old while the balance 5% are at 19 years old and above. Other plantation issues We understand that KLK has not yet been affected by the crisis in Lahad Datu. The group s estate and refining operations are still running smoothly. Approximately 7.7% of KLK s landbank or 19,399ha is in Lahad Datu, Sabah. Out of KLK s mature areas of 151,814ha, roughly 23.3% are located in Sabah (see Table 1). KLK has not started planting in Papua New Guinea yet. Instead, we understand that the group is currently clearing the land to facilitate the setting up of infrastructure. KLK had acquired a 51% stake in a company, which owns 44,342ha of land in Papua New Guinea, for US$8.7mil (RM26.9mil) in October Wheat is not expected to be KLK s core operations The group s expansion into wheat farming in Australia is not expected to be significant. Wheat farming accounted for only 0.3% of KLK s profit in FY12. We believe that there is a possibility that KLK may look to sell the land in the long term if the price is attractive. It was reported that KLK acquired 13,970 ha of land planted with wheat for RM83.2mil or RM5,951/ha in Western Australia last year. This was not KLK s foray into wheat. The group bought the first few parcels of 8,379ha for an estimated RM11.2mil (RM1,339/ha) back in Manufacturing profits to improve in FY13F We forecast manufacturing EBIT (mainly oleochemical activities) to expand by 37% to RM258mil in FY13F on the back of improved demand and operating margins. We believe that most of KLK s oleochemical earnings are from Malaysia currently. We reckon that contributions from the units in China and Europe are still small. The manufacturing division accounted for 12% of KLK s pre-tax profit in FY12. We estimate that KLK currently has 700,000 tonnes to 720,000 tonnes of refining capacity and 1.2mil tonnes of oleochemical production capacity per year. These exclude KLK s expansion into Indonesia. Impact of removal of Malaysia s GSP status in European Union (EU)? The removal of Malaysia s Generalised Scheme of Preferences (GSP) status in the EU may result in AmResearch Sdn Bhd 3

4 TABLE 2 : GAUGE OF REFINING MARGINS IN INDONESIA AND MALAYSIA Refining margin Period Details (US$/tonne) Wilmar International QFY12 Palm refineries are mainly in Malaysia and Indonesia; Pre-tax profit margin per tonne First Resources QFY12 Refinery is in Indonesia; EBITDA margin per tonne Mewah International QFY12 Refineries are in Malaysia; Operating profit margin per tonne Source: Companies, AmResearch oleochemical exports to the EU being taxed between 4% and 6%. KLK may be affected as we reckon that the EU is one of its export markets. However, there are two mitigating factors. First, Indonesia s GSP status will also be removed with effect from January 2014 onwards. Hence, Indonesia s oleochemical products would also be taxed like Malaysia s. Second, KLK has oleochemical operations in the EU. As such, the group would be able to sell its products directly to European buyers without the tax. We estimate KLK s oleochemical production capacity in the EU at 250,000 tonnes currently. However, upon completion of an additional 100,000 tonnes capacity at KLK Emmerich, the total production capacity in the EU would increase to 350,000 tonnes per year. Presently, the bulk of the manufacturing division s (mainly oleochemical activities) profits are driven by the operations in Malaysia. The division accounted for 12% of KLK s pretax profit in FY12. Updates on refining expansion in Indonesia Our earnings estimate of the manufacturing division has not accounted for contributions from the new plants in Indonesia. One of KLK s three refineries, which would be located in Belitung, is expected to be completed in the next few months. Upon completion, the refinery would have a capacity of 350,000 tonnes/year or 1,000 tonnes/day. We believe that the refinery will source part of its feedstock from KLK s palm oil mill in Belitung. KLK has roughly 20,391ha of oil palm estates in the area. The other two refineries, coupled with an oleochemical plant, would be completed by year-end. The two refineries would be located in Dumai and Mandau. Potential earnings contributions from new refineries in Indonesia? We believe that the new refineries in Indonesia would have a more significant contribution in FY14F. Assuming a pre-tax refining profit margin of US$10/tonne, then earnings from KLK s refineries in Indonesia could come up to RM39mil a year. This would increase the group s FY14F net profit by 3%. Pre-tax profit of Wilmar s palm refining division (mainly in Malaysia and Indonesia) was US$30/tonne in 4QFY12 while First Resources EBITDA per tonne for its refining operations in Indonesia was US$91/tonne (see Table 2). Operating profit margin of Mewah International s refining division in Malaysia was US$17.50/tonne in 4QFY12 (see Table 2). A key risk is the increase in refining capacity in Indonesia, which may result in an oversupply situation. According to the executive director of Indonesian Vegetable Oil Association, installed refining capacity may expand from 25mil tonnes in 2012 to 30mil tonnes in 2013F. Palm oil production in the country is forecast at 29-30mil tonnes in 2013F. Dividend yield of 3% to 4% forecast for FY13F We forecast a small increase in gross dividends from 65 sen/share in FY12 to 68 sen/share in FY13F. This implies a yield of 3% to 4% and a net payout of 61% for FY13F (2012 net payout: 57%). KLK s free cash flows are estimated at 21.6 sen/share in FY13F. Operating cash flows are expected to range from RM1bil to RM1.4bil in FY13F to FY14F. Balance sheet is envisaged to remain healthy in spite of the increase in net gearing from 1.7% in FY12F to an estimated 9.7% in FY13F. Upon completion, KLK would have 1.26mil tonnes/year or 3,600 tonnes/day of refining capacity in Indonesia in total. Including Malaysia, KLK s refining capacity would come up to almost 2mil tonnes per year. AmResearch Sdn Bhd 4

5 TABLE 3: REGIONAL VALUATION COMPARISONS PE (x) ROE (%) Dividend Yield (%) FY13F FY14F FY13F FY14F FY13F FY14F Indonesia PT Astra Agro PT Bakrie Sumatra PT London Sumatra BW Plantation Gozco Plantation PT SMART PT Salim Ivomas Pratama JA Wattie Provident Agro Multi Agro Gemilang Sampoerna Agro Simple average Singapore Wilmar International Olam International Noble Group Golden Agri Resources Indofood Agri Resources Kencana Agri First Resources Bumitama Agri Mewah International GMG Global Global Palm Resources Simple average Malaysia Genting Plantations IJM Plantations United Plantations IOI Corporation Kuala Lumpur Kepong Felda Global Ventures Kulim Sarawak Oil Palms TH Plantations TSH Resources Sime Darby Tradewinds Plantation Sarawak Plantations Hap Seng Plantations Simple average Source: Bloomberg AmResearch Sdn Bhd 5

6 TABLE 4 : FINANCIAL DATA Income Statement (RMmil, YE 30 Sep) F 2014F 2015F Revenue 10, , , , ,106.0 EBITDA 2, , , , ,348.1 Depreciation (249.7) (262.1) (270.4) (300.5) (342.2) Operating income (EBIT) 1, , , , ,005.8 Other income & associates Net interest (53.2) (36.8) (32.0) (34.5) (74.5) Exceptional items Pretax profit 2, , , , ,945.4 Taxation (420.7) (300.3) (373.1) (404.7) (447.4) Minorities/pref dividends (74.1) (48.8) (50.0) (54.2) (59.9) Net profit 1, , , , ,438.1 Balance Sheet (RMmil, YE 30 Sep) F 2014F 2015F Fixed assets 2, , , , ,583.5 Intangible assets Other long-term assets 2, , , , ,340.1 Total non-current assets 6, , , , ,284.2 Cash & equivalent 1, , , , ,507.6 Stock 1, , , , ,871.4 Trade debtors 1, , ,160.8 Other current assets Total current assets 4, , , , ,114.3 Trade creditors Short-term borrowings 1, Other current liabilities Total current liabilities 2, , , , ,825.8 Long-term borrowings , , , ,729.8 Other long-term liabilities Total long-term liabilities , , , ,236.7 Shareholders' funds 7, , , , ,774.2 Minority interests BV/share (RM) Cash Flow (RMmil, YE 30 Sep) F 2014F 2015F Pretax profit 2, , , , ,945.4 Depreciation Net change in working capital (1,091.1) (900.2) (616.7) (638.7) Others (296.7) (548.5) Cash flow from operations , , , ,648.9 Capital expenditure (305.9) (674.6) (250.0) (250.0) (250.0) Net investments & sale of fixed assets (218.5) (58.6) (64.5) (70.9) Others (93.8) (623.9) (526.3) (528.9) Cash flow from investing (259.5) (394.1) (932.5) (840.8) (849.9) Debt raised/(repaid) (33.3) (31.5) (30.0) Equity raised/(repaid) Dividends paid (678.6) (938.0) (725.9) (747.3) (800.6) Others 12.8 (34.2) Cash flow from financing (267.0) (535.8) (759.2) (778.8) (830.7) Net cash flow (610.8) (176.0) (31.6) Net cash/(debt) b/f 1, , , , ,539.2 Forex 0.0 (37.5) Net cash/(debt) c/f 1, , , , ,507.6 Key Ratios (YE 30 Sep) F 2014F 2015F Revenue growth (%) EBITDA growth (%) Pretax margins (%) Net profit margins (%) Interest cover (x) Effective tax rate (%) Net dividend payout (%) Trade debtors turnover (days) Stock turnover (days) Trade creditors turnover (days) Source: Company, AmResearch estimates AmResearch Sdn Bhd 6

7 CHART 2: PE BAND Source: Bloomberg Published by AmResearch Sdn Bhd ( P) (A member of the AmInvestment Bank Group) 15th Floor Bangunan AmBank Group 55 Jalan Raja Chulan Kuala Lumpur Tel: (03) (research) Fax: (03) Printed by AmResearch Sdn Bhd ( P) (A member of the AmInvestment Bank Group) 15th Floor Bangunan AmBank Group 55 Jalan Raja Chulan Kuala Lumpur Tel: (03) (research) Fax: (03) The information and opinions in this report were prepared by AmResearch Sdn Bhd. The investments discussed or recommended in this report may not be suitable for all investors. This report has been prepared for information purposes only and is not an offer to sell or a solicitation to buy any securities. The directors and employees of AmResearch Sdn Bhd may from time to time have a position in or with the securities mentioned herein. Members of the AmInvestment Group and their affiliates may provide services to any company and affiliates of such companies whose securities are mentioned herein. The information herein was obtained or derived from sources that we believe are reliable, but while all reasonable care has been taken to ensure that stated facts are accurate and opinions fair and reasonable, we do not represent that it is accurate or complete and it should not be relied upon as such. No liability can be accepted for any loss that may arise from the use of this report. All opinions and estimates included in this report constitute our judgement as of this date and are subject to change without notice. For AmResearch Sdn Bhd Benny Chew Managing Director AmResearch Sdn Bhd 7