Investment Highlights

• Mixed pattern of foreign shareholding before December 2018. Sime Darby Bhd (before the spin-off exercise in December 2017) or Sime Darby Plantation’s (SDP) foreign shareholding peaked at 21.15% in July 2012 and it has been sliding ever since. In the past seven years, IOI’s foreign shareholding peaked at 14.8% in May 2016. After that, IOI’s foreign shareholding has been falling. Recall that IOI’s RSPO membership was suspended in March 2016. The suspension was only lifted in early August 2016.

In contrast, KLK’s foreign shareholding climbed back to 18.2% in December 2018. This was close to the peak of 19.2% in April 2012.

As IOI and Sime Darby Plantation’s foreign shareholding have been falling in contrast to the rise in KLK’s foreign shareholding, we think that        foreign shareholders switched to KLK from IOI and SDP prior to December 2018.

KLK’s foreign shareholding has been the highest among the three big-cap Malaysian planters since September 2017.

• Foreign shareholding of all three companies started falling after December 2018. KLK’s foreign shareholding started easing after reaching a high of 18.2% in December 2018. Incidentally, CPO prices recorded a brief recovery in the first two months of 2019 after plunging in November and December 2018.

• Reasons for the fall in foreign shareholding. We attribute the fall in foreign shareholding in Malaysia’s plantation sector to a few reasons. First, country-specific reasons as reflected in the decline in the foreign shareholding of Malaysian stocks from 28.6% in March 2018 to 18.5% in September 2019 (as per Bursa Malaysia data).

Second, CPO prices have been languishing since January 2017. Since reaching a monthly average CPO price of RM3,268/tonne in January 2017, CPO prices have been in the doldrums.

Third, PE valuations of Singapore and Indonesia-listed planters are cheaper than Malaysia’s. Based on the latest Bloomberg consensus estimates and share prices, average 2020F PEs are 11.9x for Singapore-listed planters and 16.7x for Indonesia-listed companies. In contrast, average 2020F PE of the Malaysian planters is 25.4x (ex-FGV and IJM Plantations).

• Fall in foreign shareholding did not translate into a de-rating of the PE of plantation sector. Although foreign shareholding of the Malaysian planters has been declining, PE multiples of the companies remain high at more than 25x. The plantation sector in Malaysia was not de-rated. There was domestic support for Malaysian plantation companies.
• Will ESG (Environment, Social and Governance) criteria exacerbate the fall in foreign shareholding of planters? Due to the growing prevalence and importance of ESG, we think that there is risk that foreign shareholding of plantation companies may continue to fall.

Although Malaysian planters are RSPO members and do not practise unsustainable planting and estate management policies, the recent haze and forest fire incidents in Indonesia have cast the industry in a negative light.

Despite the haze incidents in 2013 and 2015, foreign shareholding of the three plantation companies was not affected. However since 2014 and 2015, scrutiny by international environmental organisations has intensified. Also, the EU has started proposing barriers on palm biodiesel.

• Implication to plantation stocks. Although there is local buying support, we are unsure if this would be enough to push up the share prices of Malaysian planters if CPO prices rebound. Without foreign participation, this would be difficult. There is risk that foreign shareholders may not return due to ESG reasons.

• Many uncertainties plaguing the sector. In conclusion, the plantation sector in Malaysia faces many uncertainties. On a positive note, we do not believe that the sector faces an existential crisis as cooking oil is a food staple. Hence, there will always be demand for palm oil from the food segment. Emerging markets in Africa could help cushion a fall in demand from the EU.

• Due to the upgrade in our recommendation for KL Kepong to HOLD from SELL, we now have a NEUTRAL stance on the plantation sector. We are in the midst of reviewing our CPO price assumption and views for 2020F. Presently, our average CPO price assumption is RM2,200/tonne for Malaysia in 2020F (2019E: RM2,100/tonne).

• So far, industry experts are predicting that CPO prices would rebound to RM2,200 to RM2,500/tonne in 2020F underpinned by a weak industry palm oil production and robust demand from Indonesia’s biodiesel industry. Indonesia’s CPO output in 2020F may be affected by the drought, which hit the country from July to September 2019.

Source: AmInvest Research - 8 Oct 2019