Investment Highlights

• Every quarter has been disappointing. Since early this year, plantation companies have been registering poor earnings as the negative impact of the plunge in CPO price was sharper than expected. In addition, CPO prices fell throughout the year instead of recovering.

• For the period of 3QFY18, most of the plantation companies recorded earnings which were below consensus estimates and our expectations. The sole exception was TSH Resources, which benefited from higher cocoa earnings and CPO output in Indonesia in 3QFY18.

• Although some plantation companies recorded robust FFB production this year, this was not enough to offset the plunge in CPO prices. Since the start of the year, CPO prices have contracted by almost 30%. We estimate that upstream EBIT or net profit of the plantation companies fell by 20% to 55% YoY in 9MFY18 or 1QFYE6/19 due to the fall in CPO prices.

• FFB production of planters were higher in 3Q2018 vs. 2Q2018. All of the plantation companies under our coverage recorded QoQ increases in FFB production of 1.1% to 22.1% in 3Q2018 except for IOI Corporation. IOI’s FFB output slid by 6.4% QoQ in 3Q2018. We believe that IOI’s FFB production fell by 6.4% from 2Q2018 to 3Q2018 as oil palm trees in Sabah were affected by tree stress and the lagged impact of the El Nino, which took place a few years ago. Companies with oil palm estates in Indonesia and Peninsular Malaysia recorded positive FFB production growth QoQ in 3Q2018.

• Downstream earnings are at an inflection point. Downstream units (mainly oleochemicals and refining) of KL Kepong (KLK) and Sime Darby Plantation registered lower earnings and squeeze in margins in 3Q2018 compared with 2Q2018. Both companies faced stiff competition, which resulted in a drop in selling prices. We believe that operating conditions in Europe are challenging. In contrast, IOI’s manufacturing unit recorded an EBIT margin of 7.1% in 3Q2018 vs. 4.5% in 2Q2018 as it benefited from higher sales volume and timely purchases of feedstock. Also, we believe that IOI sells higher value-added oleochemical products compared with KLK, which mainly sells the basic fatty acids.

• Earnings are forecast to be weaker in 4Q2018 compared with 3Q2018 due to the fall in CPO price. Average CPO price has declined by 5.6% from RM2,322/tonne in 3Q2018 to RM2,191/tonne so far in 4Q2018. We believe that this would not be offset by higher FFB production and lower production costs in 3Q2018. Peak palm production in Malaysia and Indonesia is expected to take place in either November or December 2018 while production costs are envisaged to taper off in 4Q2018. Most plantation companies would have already completed their fertiliser application by 3Q2018 before the monsoon season starts in 4Q2018.

• Underweight. Due to our sell recommendations on KLK, Sime Darby Plantation and Genting Plantations, our stance on the plantation sector is now an UNDERWEIGHT. Going forward, we believe that plantation companies would be suffering from unexciting CPO prices and rising production costs. Apart from higher minimum wage, the cost of fertiliser is expected to increase by more than 10% in 2019F.

Source: AmInvest Research - 3 Dec 2018