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Khon Kaen Sugar Industry

Entering peak earnings season

Khon Kaen Sugar Industry Plc (KSL)

Investment thesis

KSL is entering its peak earnings season of the year. We expect strong QoQ and YoY core profit growth for 2Q14 (Feb-April) and 3Q14, which together with improved sugar demand-supply dynamics should prompt the market to bid up its stock price going forward. Moreover, expectations of firmer sugar prices next year and better performances by the ethanol and power businesses should lend valuation support. We are now much more upbeat about the FY14-15 earnings outlook, so have upgraded our rating to TRADING BUY from HOLD with a new target price of Bt17.50, pegged to a PER of 15.8x (KSL's long-term mean). Below, we have laid out four investment ideas:

Theme#1—strong three-year core earnings CAGR of 20%

We forecast an FY13-16 core earnings CAGR of 20%, driven by profit expansion at the ethanol and power businesses. Also, we have revised up our FY14 earnings forecast by 4% to Bt2,075m to factor in an expanded sugar sales volume assumption of 840k tonnes, due to a better-than-expected sugar yield this year. Furthermore, there may be scope for upside to our FY14 model from capacity expansion at the ethanol and power units.

Theme#2—limited downside risk to sugar price; scope for upside

Almost 80% of KSL's sales volume already has purchasing contracts at locked-in sales prices. Moreover, the possibility of global supply shrinkage brought about by adverse weather in major producing countries could make for higher prices next year.

Theme#3—profit growth now driven by ethanol & power units

Our study of the historical relationship between the sugar price and KSL's stock price indicates that the correlation has weakened since 2012 (see Figure 10). The reason is that profitability dynamics have shifted from sugar to the ethanol and power businesses. In FY08-FY12, the sugar business ranged 60-82% of net profit. In FY13, sugar earnings comprised only 5%; in contrast power comprised 58% of the bottom-line and ethanol 36%. Last year was a particularly bad one for the sugar operation, but the power and ethanol units both almost doubled their net profits from FY12.

Theme#4—a cheap valuation

The share price implies an FY14 PER 12.7x (0.7SD below its long-term mean), which is near the lower bound of KSL's historical valuation range. Given forecast core profit growth of 46percent for FY14 (against a 40% dive last year) and a further 11percent for FY15, we believe that the stock deserves to trade at its long-term average.

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