Investment Highlights

• 2Q2019 was poor. The latest financial results of the plantation companies in our coverage were disappointing due to weak CPO prices and a QoQ drop in FFB production in 2Q2019. All of the results were below market expectations. Comparing 1H2019 against 1H2018, we estimate that upstream earnings of the planters tumbled by 30% to 50% (a few swung into losses) as average CPO price realised declined by RM400/tonne to RM500/tonne. Average CPO prices realised by the planters ranged from RM1,900/tonne to RM2,000/tonne in 1H2019.

• However, earnings are expected to improve in 3Q2019. On a positive note, we think that upstream earnings would improve QoQ in 3Q2019. This is due to recoveries in CPO price and production. Average CPO price (MPOB physical delivery) has been close to RM2,000/tonne so far in 3Q2019 vs. RM1,978/tonne in 2Q2019. Industry CPO production in Malaysia has risen by about 10% so far in 3Q2019 compared with 2Q2019. We expect industry CPO output to rise QoQ in 3Q2019 as FFB production in 2Q2019 was affected by the Hari Raya festivities.

• FFB production in Indonesia fell YoY in 1H2019, in contrast to the increase in Malaysia. Nucleus FFB production of the major plantation companies in Indonesia (listed in Singapore) fell by 5% to 8% YoY in 1H2019. Exception was Indofood Agri Group, which recorded a 1% YoY rise in FFB production in 1H2019. The YoY decline in FFB production in Indonesia in 1H2019 can be attributed to weaker FFB yields resulting from biological tree stress. This came about after two years of bumper harvest in Indonesia. In contrast, plantation companies with operations in Malaysia recorded expansions in FFB production in 1H2019. FFB output of planters in our stock universe rose by 1% to 11% YoY in 1H2019. TSH Resources recorded the lowest FFB production growth of 1% YoY in 1H2019 while FGV Holdings registered the highest FFB output increase of 11.1%.

• Industry players in Indonesia are expecting CPO production to pick up in 2H2019 after a weak 1H2019.Bumitama Agri Ltd hopes to achieve an FFB production growth of 5% to 8% in FY19E vs. a decline of 5.3% in 1H2019. Indofood Agri Resources’ FFB output is expected to rise by 5% in FY19E compared with an increase of 1% in 1H2019. Golden Agri Resources’ FFB production is envisaged to be flat YoY in FY19E after a 5% slide in 1H2019. In contrast to the above, Reuters recently reported that some Indonesian companies are expecting their FFB output to fall in 2H2019 due to the dry weather currently. Other Indonesian planters are anticipating their FFB production to be affected only in 1H2020.
• Downstream earnings were mixed in 2Q2019. Going forward, EU’s demand for oleochemical products may soften due to global economic uncertainties. This could result in weaker downstream earnings for the integrated players in the future. In 2Q2019, downstream earnings of the plantation companies were mixed. IOI Corporation’s downstream earnings declined by 27.2% QoQ in 2Q2019 due to lower refining margins. EBIT margin of the manufacturing division (ex-associates and fair value changes) edged down to 6.3% in 2Q2019 from 7.9% in 1Q2019. On the other hand, Kuala Lumpur Kepong’s manufacturing (mainly oleochemical activities) EBIT improved by 5% QoQ in 2Q2019 as the group had resolved its logistics problems in Europe. EBIT margin of the manufacturing division inched up to 5.0% in 2Q2019 from 4.7% in 1Q2019.
• UNDERWEIGHT. For now, we believe that any upside to CPO price would be capped by large palm inventories in Malaysia and Indonesia. Hence, we are keeping our UNDERWEIGHT stance on the plantation sector and our average CPO price assumption of RM2,100/tonne for 2019E (2018: RM2,235/tonne).

UNEXCITING RESULTS

• Plantation earnings were lower in 2Q2019 vs. 1Q2019

Upstream earnings of the plantation companies in our coverage tumbled by more than 30% QoQ in 2Q2019 as FFB production slid.

Some planters swung into losses in 2QFY19 such as IJM Plantations and Sime Darby Plantation’s operations in Indonesia, Liberia and Papua New Guinea.

The QoQ decline in industry FFB production in 2Q2019 resulted in an increase in the production cost per tonne, which eroded operating profit margins.

For instance, Genting Plantations’ production cost (all-in) rose to RM1,940/tonne in 2Q2019 from RM1,800/tonne in 1Q2019. FGV’s production cost (ex-mill and LLA) increased to RM1,455/tonne in 2Q2019 from RM1,379/tonne in 1Q2019.

Industry FFB production in Malaysia was weak in 2Q2019 as estate workers returned home for the Hari Raya festivities. Estate workers usually take a two-week break for Hari Raya.

In our stock universe, FFB production slipped by 1% to 10% QoQ in 2Q2019 (see Exhibit 2). FGV Holdings bucked the downward trend by recording an 8.8% QoQ increase in FFB production.

In spite of this, FGV was in the red in 2Q2019, dragged by losses in the plantation and sugar refining units.

Average CPO price realised by the companies in our coverage was flat QoQ in 2Q2019. Average CPO prices realised ranged from RM1,900/tonne to RM2,000/tonne in 2Q2019.

• FFB production of Indonesian planters fell YoY in 1H2019

FFB production of Indonesian planters listed in Singapore fell by 5% to 8% YoY in 1H2019 (see Exhibit 2). Wilmar International recorded the sharpest YoY decline of 8% in 1H2019.

On the other hand, Indofood Agri bucked the downward trend in FFB output by registering an increase of 1% YoY increase in production in 1H2019.

Wilmar’s FFB yield fell to 9.9 tonnes/ha in 1H2019 from 10.7 tonnes/ha in 1H2018. First Resources’ FFB yield slid to 7.3 tonnes/ha in 1H2019 from 8.3 tonnes/ha in 1H2018. Bumitama Agri’s FFB yield eased to 8.9 tonnes/ha ain 1H2019 from 9.7 tonnes/ha in 1H2018.

We attribute the fall in the companies’ FFB yields in 1H2019 to biological tree stress after recording a bumper harvest in the past two years.

On the other hand, FFB production of companies with operations in Malaysia increased YoY in 1H2019 as FFB yields in Sabah and Peninsular Malaysia recovered. In our coverage, FFB production of the companies improved by 1% to 11% YoY in 1H2019 (see Exhibit 2).

According to the MPOB, industry FFB yield in Sabah climbed to 9.01 tonnes/ha in 1H2019 from 8.66 tonnes/ha in 1H2018 while in Peninsular Malaysia, FFB yield edged up to 9.19 tonnes/ha from 8.14 tonnes/ha. Sarawak’s FFB yield eased to 6.76 tonnes/ha in 1H2019 from 6.87 tonnes/ha in 1H2018.

• CPO production cost per tonne rose YoY in 1H2019

Production cost per tonne of most plantation companies in Malaysia and Indonesia rose YoY in 1H2019 due to a drop in palm kernel prices and increases in the cost of wages and fertiliser.

In Malaysia, fertiliser costs increased by more than 10% YoY in 1H2019 while minimum wage rose to RM1,100/month from RM1,000/month last year.

Production cost per tonne of the Indonesian companies was exacerbated by the fall in CPO production in 1H2019.

Golden Agri’s cash costs rose to US$311/tonne in 1H2019 from US$303/tonne in 1H2018 while Bumitama Agri’s cash costs increased to Rp4,813/kg from Rp3,987/kg.

• Net gearing ratios were stable as at end-June 2019

Net gearing ratios of the companies in our coverage were stable as at end-June 2019 compared with end-March 2019 (see Exhibit 3).

TH Plantations had the highest net gearing ratio of 166.5% as at end-June 2019 while KL Kepong had the lowest net gearing of 24.0% (see Exhibit 3).

Companies with high USD borrowings include IJM Plantations and IOI Corporation. About 69% of IJMP’s RM870.6mil gross borrowings are denominated in USD while roughly 78.6% of IOI’s RM4.86bil gross borrowings are in USD.

Source: AmInvest Research - 11 Sept 2019