Bio-diesel theme for Kulim-WB

Bio-diesel theme for Kulim-WB

THE share price of Kulim (M) Bhd and its warrant Kulim-WB rose modestly last week despite the sell down of the equity market. The renewed interest could be due to a foreign broker report recommending a buy on this undervalued plantation company. At the close of last Wednesday trading, Kulim underlying and warrant closed up at RM3.02 and 84 sen respectively.

Kulim is a subsidiary of Johor Corp and is predominantly involved in plantation and oleochemicals. Recently, Kulim was in the limelight as a result of its prolonged ownership tussle involving its new acquisition of QSR Brands Bhd, the operator of Kentucky Fried Chicken and Pizza Hut. Another more exciting development going on for Kulim is its involvement with the now sexy bio-diesel venture. Under its US$40mil joint venture with Cremer Oleo of Germany, Kulim plans to build two 100,000-tonne bio-diesel plant in Tanjung Langsat, Johor and in Jurong, Singapore.

Kulim reported a net profit after tax and minority interest of RM41.8mil in 2005. This is a sharp drop from RM168.3mil the group achieved the previous year. However, Kulim is expected to see a sharp rebound in earnings according to the broker’s report.

Kulim is also trading way below its net asset value of RM10.83 per share. With the development of the Southern Johor Corridor under the Ninth Malaysian Plan, investors may start to realise that the revaluation done on Kulim’s landbank which substantially boosted its book value is in fact realistic. An added appeal on Kulim is the bio-diesel play which saw many companies' share prices shot up. A laggard in this sector, Kulim’s involvement in bio-diesel is actually much larger than most other “bio-fuel” companies.

At the last traded price of RM0.84, Kulim-WB is trading only at a premium of 8.3%. This is based on the latest exercise price of RM2.43 following the adjustment to Kulim-WB's exercise price after the capital distribution of Johor Land share for Kulim shareholders recently. This is a rather small premium for a company with Kulim’s potential. Even though Kulim does pay a dividend of 7.5 sen last year, its dividend yield is not considered excessive to disinterest warrants buyer.

Kulim-WB is now trading at an implied volatility of 27%. This is slightly higher than the company’s short term historical volatility of 23%. Given the fact that Kulim's share price is expected to be volatile in view of the never ending QSR saga coupled with bio-diesel excitement, such valuation is quite reasonable.

Kulim’s historical volatility in the last one year had range from as low as 5% to almost 40%.

Kulim-WB has a gearing of 3.6x and an effective gearing of 2.5x. Gearing indicates the extent by which the warrants rise or fall given a one percentage point rise or fall in the price of the underlying share. This is especially useful when the warrant becomes in-the-money like in the case of Kulim-WB. While gearing assumes a similar change in the prices of underlying share and warrant, effective gearing takes into consideration the delta. Delta indicates the change in a warrant’s theoretical value, in absolute terms, given a one-unit change in the price of the underlying share. Effective gearing therefore gives a more accurate measure of actual leverage provided by the warrant. In Kulim-WB's case, a warrant investor can expect it to outperform the underlying share by 2.5x when the underlying share goes up.

If shareholder of Kulim is betting for a big advance in Kulim’s price over the next one year, one strategy he can consider would be to switch from Kulim underlying share, whose price is near a 52-week high, to Kulim-WB. For every Kulim share he sells, he should theoretically buy 1.4 unit (arrived by dividing 1 with the delta value of 0.72) of Kulim-WB to approximate the same upside potential as if he is still holding on to Kulim share. This way, the investor can free up cash of RM1.84 for every Kulim share he sells. If Kulim's share price decline, the maximum loss he would suffer is RM1.18 although Kulim-WB tend to be more resilient at a lower absolute price.



·Alan Voon is a warrants specialist