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Kenanga Research & Investment

Author: kiasutrader   |   Latest post: Mon, 24 Jun 2019, 10:17 AM

 

Plantation - Rotting Fruits

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We are cutting our 2019-2020 CPO price forecast from RM2,400-2,400/MT to RM2,000-2,200/MT as negative news flows vis-à-vis palm-oil biodiesel ban from the Europe (EU), a potential CPO inventory pickup in 2H19, and intensifying trade war tensions are all keeping CPO prices under pressure. PostCPO price revision, we slash planters’ earnings by 6-97% (mean: 42%) for FY19E and 7-79% (mean: 32%) for FY20E with pure upstream players such as IJMPLNT and HSPLANT taking bigger hits. We also take this opportunity to roll forward our earnings/valuation base year to CY20 from CY19 earlier. Consequently, TPs of the companies are reduced by 2-23% (mean: 10%), with valuations generally pegged at -1.0SD to -2.0SD PER/PBV levels, except for PPB (valued at the mean level due to its welldiversified earnings base) and TAANN (valued at -0.5SD as earnings should be supported by improving log production). Lastly, we are downgrading the plantation sector from NEUTRAL to UNDERWEIGHT, with 7 UNDERPERFORM calls, 4 MARKET PERFORM calls and only 1 OUTPERFORM – TAANN. We believe planters’ earnings will hit a rough patch in coming quarters with CPO prices hovering around current levels, which will likely overshadow any production pickup in 2H19. While biodiesel mandates seem to be panning out well (expected to absorb c.13% of CPO production in Indonesia and c.4% in Malaysia), the intensifying US-China trade war tensions are likely to discourage soybean oil prices like what happened last year. In our opinion, this will dwarf any positive trade/demand impact on CPO and keep its prices under pressure in the near term, as the two commodities are close substitutes with their prices highly correlated (>0.90). Our top pick and only OUTPERFORM call is TAANN (OP; TP: RM2.75), due to its: (i) 2-year CNP CAGR of 12.8% (driven by improving log production), (ii) profitable status despite the depressed CPO price environment, and (iii) attractive dividend yield of 4.0%.

End of grace period for CPO. We were previously hopeful of a handsome CPO price recovery by June 2019 as stockpiles fall and demand from China picks up. However, despite the positives nicely falling into place, negative news flows vis-à-vis palm-oil biodiesel ban from the Europe (EU) has proven to be a major killjoy. As we move closer to 2H19, chances of CPO price reaching our 2019 target of RM2,400/MT are becoming next to zero. To put things into perspective, CPO prices have to average c.RM2,700/MT for the rest of the year in order to hit our target, while going against the grain of potentially rising stockpiles in 2H19 (to 3.0-3.5m MT levels). As such, we are cutting our 2019-2020 CPO price forecast from RM2,400-2,400/MT to R1M2,000-2,200/MT.

Sector-wide earnings cut. Post-CPO price revision, we slash planters’ earnings by 6-97% (mean: 42%) for FY19E and 7- 79% (mean: 32%) for FY20E with pure upstream such as IJMPLNT and HSPLANT taking bigger hits. We also take this opportunity to roll forward our earnings/valuation base year to CY20 from CY19 earlier. Consequently, TPs of the companies are reduced by 2-23% (mean: 10%), with valuations generally pegged at -1.0SD to -2.0SD PER/PBV levels, except for PPB (valued at the mean level due to its well-diversified earnings base) and TAANN (valued at -0.5SD as earnings should be supported by improving log production). We reckon the valuation bases are well justified considering that the heyday of high ROEs for planters is observably over (see Exhibit 1).

Downgrade from NEUTRAL to UNDERWEIGHT. In light of the depressed CPO price environment, we are downgrading the plantation sector from NEUTRAL to UNDERWEIGHT, with 7 UNDERPERFORM calls, 4 MARKET PERFORM calls and only 1 OUTPERFORM – TAANN. We believe planters’ earnings will hit a rough patch in coming quarters with CPO prices hovering around current levels, which will likely overshadow any production pickup in 2H19. While biodiesel mandates seem to be panning out well (expected to absorb c.13% of CPO production in Indonesia and c.4% in Malaysia), the intensifying US-China trade war tensions are likely to discourage soybean oil prices like what happened last year. In our opinion, this will dwarf any positive trade/demand impact on CPO and keep its prices under pressure in the near term, as the two commodities are close substitutes with their prices highly correlated (>0.90). Coupled with a potential inventory pickup in 2H19 (to 3.0-3.5m MT levels), we believe the possibility of a strong CPO price recovery in the near term can be practically ruled out, leaving 2019 an unexciting year for most planters. Nevertheless, should the Chinese and/or biodiesel demand be stronger-than-expected, resulting in falling stockpiles in 2H19 and a sharp recovery in CPO prices, we would review our sector call and TPs of planters under our coverage.

Source: Kenanga Research - 21 May 2019

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