Plantations - A Better 2H

Date: 25/09/2020

Source  :  PUBLIC BANK
Stock  :  TAANN       Price Target  :  3.68      |      Price Call  :  BUY
        Last Price  :  2.91      |      Upside/Downside  :  +0.77 (26.46%)
Source  :  PUBLIC BANK
Stock  :  SWKPLNT       Price Target  :  2.85      |      Price Call  :  BUY
        Last Price  :  2.43      |      Upside/Downside  :  +0.42 (17.28%)
Source  :  PUBLIC BANK
Stock  :  TSH       Price Target  :  1.45      |      Price Call  :  BUY
        Last Price  :  1.09      |      Upside/Downside  :  +0.36 (33.03%)

CPO prices have soared more than 45% to RM2,933/mt after hitting the low of RM2,022/mt in May. The strong rally was contributed by i) weaker CPO production in Indonesia, ii) low inventory levels recorded in Malaysia and iii) strong palm oil demand from China. It is a big cheer for the plantation sector as the strong CPO prices come amid the high production period. We expect to see stellar plantation earnings performance in the 2H on the back of strong margin expansion. In view of the better-than-expected CPO prices, we revise up our 2020 CPO price forecast from RM2,500/mt to RM2,600/mt, raising our EPS forecast by 5%-10% across plantation companies under coverage. We also increase our PE multiple by 1x to reflect the positive CPO price outlook in the near-term. Our top picks are Sarawak Plantation, Ta Ann and TSH given their more attractive valuations and stronger-than-average FFB production growth. Maintain Neutral on the sector as we expect a softer CPO price of RM2,500/mt in 2021. '

  • Demand from India making a comeback. Following the softer stance on the trade policy due to the improved diplomatic relations between Malaysia and India since May, we saw a strong palm oil demand from India, who is the world biggest palm oil consumer. India is currently our third largest export destination, making up 10.5% and is likely to climb to second spot in the coming months. Nevertheless, with the current high CPO prices and less competitive levels compared to other vegetable oils, we think India’s palm oil demand could soften in the coming months. Nevertheless, CPO is becoming less price sensitive compared to other vegetable oils, as such, we think India may switch into cheaper alternatives, leading to softer CPO demand in the coming months.
  • Double happiness for plantation companies. CPO prices normally trade lower in the second half due to the upward pressure on palm oil inventory as production is seasonally higher towards the year-end. Since 2007, there were only seven years that saw CPO prices traded above RM2,500/mt in the 2H and only three years, namely, 2010, 2011 and 2016, where the CPO price strength sustained towards the year-end. Given the supply concern and positive export data coupled with low inventory levels, CPO prices have been strengthening above RM2,700/mt since last month with a YTD average of RM2,580/mt, which is above the consensus forecasts. Plantation companies are benefitting from both higher production as well as stronger CPO prices. Therefore, we expect a sharp margin expansion for the plantation companies in the 2H.
  • Low inventory levels seen in Malaysia and Indonesia. YTD, palm oil inventory level in Indonesia and Malaysia have shrunk 21% and 15.5% to 3.62m mt and 1.69m mt, respectively. The current low inventory levels in the top two palm oil producing countries were mainly due to weaker production despite weaker exports. Palm oil supplies have become a main concern due to the issue with foreign labour shortage in Malaysia as border restriction is still in place.
  • Windfall tax making a comeback. In Dec 2019, the Malaysian Palm Oil Board (MPOB) said the windfall profit tax on planters is imposed only when the CPO prices surpass the threshold level set in 2009. To recap, oil palm planters in the Peninsular have to pay a 3% windfall tax per tonne when palm oil prices go beyond RM2,500/mt in the cash market. Planters in Sabah and Sarawak, however, only need to pay a 1.5% windfall tax per tonne if the price crosses RM3,000/mt. In our view, any adverse impact to earnings is relatively low given the sharp margin expansion.
  • Anticipating first annual production drop in Indonesia. The lack of fertilizer application between 2018 and 2019 as planters tried to contain cost pressure when prices were low and the dry weather in the middle of 2019, have resulted in diminished oil palm fruit yields, thereby, curbing the production growth in Malaysia and Indonesia. Indonesian Palm Oil Association, Gapki, has recently forecasted the Indonesia’s palm oil output to drop from 47.1m mt to 46m mt, the first annual decline since 2009. Meanwhile, Malaysian production is estimated to drop by 1% to 19.7 m mt this year, according to the Malaysian Palm Oil Council.
  • Concern on the emergence of La Lina event. Australia’s Bureau of Meteorology has recently forecasted above average rainfall for the remainder of the year. It raised the outlook to La Nina alert, meaning that there is at least a 70% chance of La Nina forming in 2020. A severe La Nina event could bring heavy rainfall in Malaysia and affect the transportation and harvesting activities in the palm oil estates. Over the last 12 years, there is occurrence of four La Nina events, which fell in the year of 1997/98, 2002/2003, 2006/2007 and 2009/2010. The impact of La Nina pose a bigger threat on soybean oil than palm oil as it can bring drier weather pattern to the crops in North and South America regions.
  • Labour shortage issue under control. Based on our channel checks, some plantation companies claimed that they have been suffering from the labour issues over the years but it is under control. Back in June, Malaysian government has frozen on recruitment of foreign workers until year-end. According to various reports, the industry is facing a shortage of 37,000 workers- nearly 10% of the workforce and the figure could balloon to as high as 70,000 when the borders reopen. The labour shortage will impact the year’s output due to the delay in harvesting the perishable fruits. Nevertheless, the government has relaxed the ruling by allowing the foreign workers, who have their employment contract expired, to be re-employed.
  • Limited upside for CPO prices. Despite the recent CPO price rally, we think CPO prices could turn weaker in the coming months from current strong levels on rising output and slower exports. Oil palm crop production is likely to increase gradually from Sept to Nov while the demand is expected to taper off from the high restocking activity in the major importing countries, while supported by festive demand during the Chinese Mooncake Festival and the Diwali celebration in Nov. Meanwhile, we raise our CPO price forecasts from RM2,500/mt to RM2,600/mt to reflect the stronger-than-expected CPO price performance in 2H. YTD, it averages at RM2,570/mt, 21% higher compared to 2019’s RM2,128/mt.
  • Weaker production seen. Almost all plantation companies (refer to Figure 10) except Sarawak Plantation registered weaker FFB production YTD. A couple of factors contributed to the weaker production, i) labour shortage, ii) weaker FFB yield due to the impact of a cut in fertliser application over the last 2 years and iii) lagged effect of dry weather. For the first 8 months, GENP registered the steepest drop, - 9.9%, followed by FGV’s -8.4%, IOI Corp’s -7.3% and Sime Plant’s -7.2%.
  • Prefer small-cap plantation companies. Following our upward revision in our 2020 CPO price forecast from RM2,500/mt to RM2,600/mt, we raise our FY20 EPS forecast by 5%-10% for the respective plantation companies our coverage except Sarawak Plantation, which will see exceptionally stronger earnings growth of more than 30% thanks to their strong FFB production growth. We also increase our PE multiple by 1x to reflect the positive CPO price outlook in the near-term. We upgrade Ta Ann (TP: RM3.68) to Outperform call given its current attractive valuations. Other outperform calls include Sarawak Plantation (TP: RM2.85) and TSH (TP: RM1.45). However, our Neutral call on the sector outlook remains. We suggest investors to look into small-mid cap plantation companies, which give more attractive upside compared to the big cap.

Source: PublicInvest Research - 25 Sept 2020

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