Investment Highlights

• What were the crisis level valuations for palm oil companies? In this report, we look at the trough valuations of plantation companies during the 2008/2009 global financial crisis. Comparing trough and current valuations, we believe that plantation companies are only a small way through the valuation down cycle. This implies that there is a risk of a further PE de-rating. We do not have any BUY in our stock universe.

• CPO price downturn – eight to nine months. Share price downturn – nine and a half months. During the 2008/2009 global financial crisis, the fall in CPO price from the peak to the bottom took about eight months. CPO price reached the highest level of RM4,203/tonne on 4 March 2008 and the lowest level of RM1,404/tonne on 18 November 2008. This was a plunge of 66.6% from peak to trough.

• Share prices of the planters took about nine and half months to bottom out after sliding from their highs. The KL Plantation Index peaked at 8,822.63 points on 15 January 2008 and fell by 64.6% to a low of 3,119.48 points on 28 October 2008. Quantitative easing by the US Federal Reserve and unfavourable weather conditions in Malaysia and Indonesia led to the recovery in CPO price and global equities in 4Q2008 and 1Q2009.

• Trough historical PEs of 4.0x to 9.0x for big caps. During the 2008/2009 global financial crisis, the historical PE multiples of Kuala Lumpur Kepong and IOI Corporation dropped to lows of 7.3x and 5.1x respectively. Genting Plantations’ (GenP) crisis low PE was 4.1x on 28 October. As at 16 March 2020, the three companies were trading at FY20F PEs of 22x to 28x. Sime Darby Plantation’s FY20F PE was 34.4x.

• KLK’s share price plunged by 62.8% to RM7.15 on 29 October 2008 from the high of RM19.20 on 14 February 2008. IOI’s share price dived by 74.4% to RM1.688 on 28 October 2008 from its high of RM6.59 on 15 January 2008. GenP’s share price fell by 71.3% to a low of RM2.457 on 28 October 2008 from a high of RM8.553 on 29 February 2008. Average MPOB spot prices were RM2,867/tonne in 2008, RM2,240/tonne in 2009 and RM2,740/tonne in 2010.

• Trough historical PEs of 5.0x to 7.0x for smaller planters. IJM Plantations’ (IJMP) trough PE was 5.1x on 28 October 2008 while TSH Resources hit a crisis level PE of 4.3x on 29 October. IJMP’s share price fell by 66.4% to the lowest level of RM1.329 on 28 October from a high of RM3.958 on 27 February 2008 while TSH’s lowest share price was RM0.393 on 29 October 2008 vs. a high of RM1.24 on 14 January 2008.

• KLK and IOI traded at crisis lows P/BV of 1.4x and 1.3x respectively in 2008. In comparison as at 16 March 2020, KLK’s P/BV was 1.9x while IOI’s P/BV was 3.1x. Sime Darby Plantation’s P/BV was 1.8x. As for the smaller companies, IJMP’s P/BV fell to a low of 1.1x in 2008/2009 while TSH’s lowest P/BV was 0.7x. GenP’s P/BV fell to a low of 0.8x during the 2008/2009 global financial crisis.

• Then vs. Now — what has changed? First, the cost of CPO production has increased. Second, downstream operations of the integrated players have become larger due to bigger production capacity. Third, the planted areas of the plantation companies have also grown due to the aggressive new plantings carried out before 2010. Fourth, foreign shareholding in the plantation sector is lower compared with 2008/2009. Fifth, ESG (environmental and social governance) concerns are more prominent now.

• The silver lining is that the balance sheets of most plantation companies are still as clean as they were back in 2008/2009.

• Currently, we believe that the all-in industry cost of CPO production is about RM2,000/tonne to RM2,400/tonne. In comparison, we believe that the all-in industry cost of CPO production was about RM1,000/tonne to RM1,500/tonne in 2008/2009. The increase in production cost per tonne can be attributed to higher costs of labour and other inflationary pressures affecting cost components such as housing and infrastructure.

• Foreign shareholding in Sime Darby Bhd (before the spin-off exercise) was 21.1% as at end-January 2008. In contrast, foreign shareholding in Sime Darby Plantation was only 10.6% as at end-February 2020. KLK’s foreign shareholding was 17.5% as at end-August 2011. As at end-February 2020, KLK’s foreign shareholding was 14.16%. As for IOI, its foreign shareholding has fallen to 7.12% as at end-February 2020 from 16.7% as at end-March 2010.

• ESG has become an important criterion in fund investments in the past two to three years. In the plantation space, there has not been any official announcement of foreign funds exiting palm oil companies because of environmental concerns. This is in contrast to investments in coal companies. In January 2020, Black Rock announced that it would exit companies where more than 25% of their sales are from coal. In 2019, Norway’s sovereign fund said that it would stop investing in companies that mine more than 20mil tonnes of thermal coal.

• What are the implications? First, it is inevitable that the downturn in CPO prices would affect plantation earnings. This is because even though CPO prices are falling, industry cost of production may not fall as much. We think that only transportation costs, which account for 5% to 10% of production cost, would decline in FY20F. Cost of wages is expected to rise due to the hike in minimum wages while fertiliser costs are envisaged to remain flat in FY20F. Plantation companies have locked in their fertiliser costs late last year for six to 12 months of supply. Hence, they may not benefit if fertiliser costs fall due to the plunge in crude oil prices.

• Second, although the integrated companies have expanded their downstream operations by increasing capacity, we believe that in a global economic slowdown, downstream businesses may not provide a cushion to falling upstream profits. Apart from lower demand, selling prices of oleochemical products may also decline due to stiff competition among the producers. In FYE9/09, KLK’s manufacturing EBIT shrank by 69.7% to RM35.5mil partly due to write-down of inventories. On the other hand, while IOI managed to sustain its manufacturing EBIT at RM650.9mil, IOI’s reported net profit plunged by 55.9% to RM983.5mil in FYE6/09 dragged by a write-down of its Sentosa Cove property development project in Singapore (before IOI’s spin-off exercise) and losses on foreign currency forward contracts.

• On a positive note, due to lower levels of foreign shareholding, the selldown of Malaysian plantation stocks may not be as sharp as 2008/2009. Share prices of the companies in our universe dived by 43% to 80% during the global financial crisis in 2008/2009. IOI recorded the sharpest fall of 74.4% in 2008/2009 while TH Plantations registered the smallest decline of 43.7%. Currently, foreign shareholding of IOI and Sime Darby Plantation are 50% to 60% below their levels in 2008/2009. The exception is KLK, whose foreign shareholding dropped by a mere 3 percentage points from August 2011 to February 2020.

• Balance sheets of most planters are clean. We do not expect most of the plantation companies in our coverage to face financial difficulties as their net gearing ratios are below 50% (KLK, IOI, GenP and IJMP). Also the interest coverage of companies with high net gearing ratios are comfortable. Hence, we do not envisage any default in the plantation sector. We estimate Sime Darby Plantation’s interest coverage to be 12.1x in FY20F while TSH’s interest coverage is anticipated to be 3.3x. Sime Darby Plantation’s net gearing was 72.0% as at end-December 2019 (including RM2.2bil perpetual sukuk) while TSH’s net gearing was 90.8%.

• Lower fair values for our stock universe. We have reduced the fair values of the companies in our coverage by 20% to 53% to account for lower PE assumptions. The sharpest downward revision was in respect of TH Plantations. Our fair value for THP has been reduced to RM0.19/share from RM0.40/share due to a P/BV assumption of 0.3x instead of 0.6x previously. We are now assuming a PE of 20x each for IOI, KLK and GenP and 18x each for IJMP and TSH on FY21F earnings. Previously, we had assumed PEs of 25x-27x on the companies’ FY20F earnings.

• Maintain CPO price assumption of RM2,300/tonne for Malaysia in 2020F. For now, we think that this is conservative enough to reflect the weak global demand for palm oil from the food and biodiesel segments. Also demand for palm oil may be soft as the price difference between CPO and other vegetable oils is still narrow. As at 16 March 2020, CPO was US$36/tonne or 6.4% cheaper than US soybean oil vs. the five-year average discount of 19.3%. Global discretionary demand for biodiesel may ease going forward as fossil fuels are cheaper. Currently, gasoil is US$217/tonne cheaper than CPO.

Source: AmInvest Research - 18 Mar 2020