The head and body of coconut farmer Felix Salcedo, 65, was found on the outskirts of the Basilan capital of Isabela, said Cris Puno, spokesman for Gov. Wahab Akbar.
"The old man was beheaded," Puno said, adding they did not know who was behind the killing.
Police sources said they were looking into possible involvement of the Abu Sayyaf who are notorious for kidnappings for ransom and attacks on Christians and foreigners in the south.
The Abu Sayyaf, who are linked to the al-Qaeda terror network of Osama bin Laden, are known to seize Christian villagers and behead them to distract government forces from pursuing them.
Some 1,000 American soldiers have been deployed in the southern Philippines to help local troops track down the Abu Sayyaf.
The ranks of the notorious kidnapping gang have been decimated in recent months, but most of the top leaders of the Abu Sayyaf have escaped arrest.
The American troops are barred from engaging in combat and can only fire in self-defense. They are due to end their six-month deployment here on July 31.