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Kenanga Research & Investment

Author: kiasutrader   |   Latest post: Thu, 23 Jan 2020, 9:15 AM

 

Plantation - CPO Demand-Supply Dynamics Improving

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We are revising up our CY19-20 CPO price forecast (from RM2,000-2,200/MT) to RM2,100-2,400/MT and upgrading the plantation sector to NEUTRAL. There are increasing signs pointing towards the possibility of CPO demand growth outpacing supply growth. CPO production is expected to slow down from the lagged impact of dry weather earlier this year and cost managing maneuvers such as lower fertiliser application as well as slowdown in new plantings. Meanwhile, demand for CPO is expected to remain robust stemming from: (i) expected implementation of biodiesel mandates in Malaysia (B20/10 for the transport/industrial sector) and Indonesia (B30), resulting in an aggregate c.3.6m MT additional CPO consumption, as well as (ii) continuous strong Chinese demand due to the African swine fever outbreak. Risks, however, lies in the successful and timely implementation of the biodiesel mandates, especially Indonesia’s B30. Moreover, current CPO-Gasoil discount has narrowed to a mere USD2/MT (vs. 1-year average of USD115/MT), which could discourage additional discretionary biodiesel blending. Having said that, our in-house Brent crude oil forecast for CY20 of USD65/barrel, translating into USD477/MT (+8% from current USD441/MT), suggests that CPO-Gasoil discount should widen, providing a reprieve. Following the sharp recovery in CPO prices which is currently very close to 3-year mean of RM2,404/MT), we reckon planters’ valuations should re-rate closer to mean valuations. All-in, after weighing the potential positives and negatives above, we believe 2020 will spell out a better year for planters. In anticipation of a better year ahead, we upgrade our stance on the sector from UNDERWEIGHT to NEUTRAL. Our preferred picks are KLK and HSPLANT.

Outlook is improving. There are increasing signs pointing towards the possibility of CPO demand growth outpacing supply growth such as: (i) impact of dry weather on Indonesia and Malaysia’s CPO productions in 2020, (ii) expected implementation of biodiesel mandates in Indonesia (B30) and Malaysia (B20/10 for the transport/industrial sector) representing an additional c.3.6m MT CPO consumption in total, and (iii) stronger-than expected demand from China due to African swine fever outbreak. Alongside recovery in CPO prices, we are upgrading the Plantation sector from UNDERWEIGHT to NEUTRAL with higher CY19-20 CPO price target of RM2,100-2,400/MT.

Production showing signs of slowing. According to the World Meteorological Organization (WMO), sea surface temperatures (SST) in the tropical Pacific Ocean were at weak El Niño levels (0.5-0.9°C above average SST) from April to June 2019. Similarly, Malaysia and Indonesia experienced dry weather in June which continued into early-October, with more severe conditions for the latter. As such, we foresee a lagged impact (typically 6-12 months later) on CPO production. Additionally, the Malaysian Palm Oil Board (MPOB) recently revised its 2019 CPO production lower to 20.0m MT (from 20.3m MT), now implying only +2.5% YoY growth (from +4.1% YoY growth). This, alongside lower application of fertiliser and a slowdown in new plantings to manage costs during depressed CPO price environment in 2018-to-mid-2019 should result in a slowdown in global CPO production into 2020.

Robust demand for CPO. The expected implementation of B30 mandate in Indonesia, and Malaysia’s targeted B20/B10 for the transport/industrial sector is estimated to increase CPO consumption by an extra c.3.6m MT (+4.9% YoY from FY19E global consumption of 72.9m MT) for biodiesel alone. According to Thomas Mielke at the Indonesian Palm Oil Conference (IPOC 2019), CPO production is estimated at 78.2m MT while consumption is forecasted to reach c.80m MT, corroborating our view. Meanwhile, strong demand for palm oil as a substitute to soybean oil in China is expected to continue as soybean crushing activities remain low. To put things in perspective, the African swine fever outbreak has reduced China’s pig herd by c.40% and consequently demand for soy meal. A recovery in our opinion, is likely to take 6-12 months, given that the disease is still spreading in some parts of the country. In essence, we believe demand for palm oil will remain robust and with production showing signs of slowing, it builds a case for demand growth to potentially outpace supply growth.

But with a caveat - successful implementation of biodiesel. One of the key drivers to CPO consumption growth hinges on the successful implementation of biodiesel mandates, especially Indonesia’s B30 mandate. Despite positive interim road test results for B30 (in Sep 2019) in Indonesia , we understand that there are still more tests required. Meanwhile, Malaysia has yet to begin road tests on B20. As such, the timeliness and successful implementation of the biodiesel mandates remains a risk. Moreover, current CPO-Gasoil discount has narrowed to a mere USD2/MT (vs. 1-year average of USD115/MT), which could discourage additional discretionary biodiesel blending. Having said that, our in-house Brent crude oil forecast for CY20 of USD65/barrel, translating into USD477/MT (+8% from current USD441/MT), suggests that CPO-Gasoil discount should widen, providing a reprieve.

Sharp recovery in CPO price a re-rating catalyst. Based on MPOB’s data, CPO prices have recovered c.29% from a low of RM1,865/MT to RM2,406/MT currently. Following the sharp recovery in CPO prices, we believe planters’ valuations are due for a re-rating. On average, planters were trading at -1.0SD from their respective mean PER/PBV prior to the sharp recovery in CPO prices. We reckon at current CPO price of RM2,406/MT (very close to 3-year mean of RM2,404/MT), planters’ valuations should re-rate closer to mean valuation.

New CY19-20 CPO target of RM2,100-RM2,400/MT. We are revising up our CY19-20 CPO price forecast (from RM2,000- 2,200/MT) to RM2,100-2,400/MT. For the rest of CY19 and into CY20, we believe CPO price should trade around the range of RM2,300-2,500/MT, supported by: (i) strong Chinese demand, (ii) healthy soybean oil-crude palm oil (SBO-CPO) premium of USD118/MT (close to 3-year average of USD113/MT), and (iii) weaker ringgit (CY19E USD/MYR of 4.20 vs. current USD/MYR of 4.12). Post-CPO price revision, we upgrade planters’ earnings on average for FY19E by 35% (coming from a lower base) and FY20E by 24%. Consequently, our TPs of the companies are revised 1-30% with valuations generally pegged at -1.0SD to mean PER/PBV levels, except for CBIP (valued at -2.0SD as its plantation segment is only expected to break even in FY20).

Upgrade the Plantation sector to NEUTRAL. All-in, after weighing the potential positives and negatives above, we believe 2020 should spell out a better year for planters. In anticipation of a better year ahead, we upgrade our stance on the sector from UNDERWEIGHT to NEUTRAL, with 3 OUTPERFORM calls, 9 MARKET PERFORM calls and only 1 UNDERPERFORM call – PPB (refer to Exhibit 4 for more details).

Our preferred picks of the sector are KLK and HSPLANT.

(i) KLK (OP; TP: RM24.60). At current price, KLK is trading at Fwd. PBV of only 2.2x (implying -2.0SD from mean) which we believe is unjustified given its: (i) above-average FFB growth (for big caps) of 4.3%, (ii) above-sector average FY20 ROE of c.8% (vs. sector’s average of c.5%), and (ii) decent dividend yield of 2.2%.

(ii) HSPLANT (OP; TP: RM1.70). We like HSPLANT as a pure upstream planter allowing it to capitalize on the recovery in CPO price to a greater extent. Its zero exposure to Indonesia also allows it to mitigate the impact of the dry weather. At current price, HSPLANT is trading at Fwd. PBV of only 0.74x (implying -1.5SD from mean) which we think is unwarranted given its: (i) above-average FFB growth prospect of 4.5%, (ii) net cash position of c.RM52m, and (iii) low EV/planted Ha of RM33k, implying 20% discount to small cap planters’ average EV/planted Ha of RM41k.

Source: Kenanga Research - 8 Nov 2019

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