KL Kepong - further upside in Batu Kawan?

Further upside in Batu Kawan?

Batu Kawan as a cheaper but more illiquid entry to KLK. We have been pushing KLK as our top pick among the Msian plantation big caps. KLK's cheaper but more illiquid proxy, Batu Kawan (BAK MK, not rated, last price RM11.82) has started to move up recently, up 10% MoM. Batu Kawan owns 47% of KLK and some chemical manufacturing entities.

Batu Kawan’s discount to its KLK stake has widened, mean reversion suggests further upside. We examine the historical discount of Batu Kawan's market cap to the market value  of its 47% KLK stake (see chart below). At last close, the discount was 40%, vs a 10 year mean of 31%. A reversion to mean (assuming KLK remains unchanged at RM17,90) would suggest Batu Kawan trades up to  RM13.70, implying 16% upside.

Implied valuation of Batu Kawan undemanding. KLK contributed 92% of BK pre-ex profits in FY09. Based on our KLK forecasts and assuming chemical earnings stay flat, Batu Kawan
would trade at 11.4x FY10 PER and 10.4x FY11 PER. At the mean reversion price of RM13.70, Batu Kawan would trade at 13.2x FY10 PER and 12.1x FY11 PER.

KLK remains our top pick among the plantation big caps. KLK remains attractively valued relative to its big-cap peers, especially given its superior FFB growth profile. Positive newsflow on the non-plantation  businesses such as: 1) narrowing losses at the non-oleo manufacturing entities, and 2) a profitable Crabtree & Evelyn, could further enhance sentiment on the stock, in our view.

Price target of RM18.30. Our target price is based on a sum of parts, with the plantations, manufacturing and retail divisions on DCF, and property on RNAV. At our target price, KLK would trade at 19.6x FY11 PER.