Investment Highlights

• Upgrade sector to NEUTRAL from UNDERWEIGHT. We upgrade the recommendations on our plantation stocks from SELL to HOLD. Although we have a HOLD on Kuala Lumpur Kepong (KLK), we would recommend KLK (fair value: RM24.40) for investors, who would like exposure to the palm oil sector. This is due to KLK’s young oil palm trees in Indonesia and cheaper PE relative to the other large-cap planters.

• We are neutral on the plantation sector as we think that there is a balance between the positive and negative factors. Although palm demand from India and China is improving, this is expected to be offset by climbing palm production in Malaysia and Indonesia in 2H2020. As prospects are not as bleak as before, we have raised the fair values for the companies in our stock universe on higher PE assumptions. Our previous PE assumptions were based on trough market conditions. We have assumed PEs of 27x for large-caps like IOI Corporation and Kuala Lumpur Kepong (vs. 20x previously) and 22x–25x for smaller companies like IJM Plantations and TSH Resources (vs. 18x previously).

• We would turn positive on the plantation sector if palm inventory declines. Generally, palm production declines when unfavourable weather affects FFB yields. Currently, palm inventory is forecast to rise on the back of higher production. Malaysia’s palm inventory stood at 2.03mil tonnes as at end-May 2020 vs. 1.76mil tonnes as at endJanuary 2020 and 2.45mil tonnes as at end-May 2019.

• Average CPO price assumption of RM2,300/tonne in 2020F (5M2020 average MPOB price: RM2,497/tonne; 2019 average MPOB price: RM2,119/tonne). We expect plantation companies to record higher net profits in 2020F underpinned by an average CPO price of RM2,300/tonne vs. the MPOB’s average price of RM2,119/tonne in 2019. On the back of an 8.5% increase in average CPO price realised in 2020F, net profit growth is estimated to be 10% to 40% for upstream operations. We believe that upstream earnings would be stronger in 2020F if not for the weak industry FFB production and rising production costs. As for the downstream segment, net earnings of the integrated planters may be affected by erosion in refining or oleochemical EBIT margins. Downstream profit margins are anticipated to be hit by lower selling prices of non-healthcare oleochemical products and sales volume.

Outlook and developments in 2H2020

• Industry palm demand to recover in 2H2020. We believe that global palm demand would recover in 2H2020 underpinned by a resumption of business activities. In China, a gradual reopening of restaurants would improve the demand for cooking oil. Based on anecdotal evidence, palm oil is usually mixed with peanut oil or other oils in China. We believe that cooking oil accounts for about 30% of palm usage in China while frying oil accounts for another 25%. Oleochemical takes up another 30% of palm oil used in China. Also, the reopening of India’s economy in June 2020 would result in restocking of vegetable oils as stockpiles are currently low. As at 1 March 2020, inventory of edible oils at the pipelines and ports in India stood at 1.53mil tonnes vs. 2.2mil tonnes a year ago.

• But palm demand may not reach the highs of 2019. We believe that Malaysia’s palm exports in 2020F would not reach 2019’s peak of 18.5mil tonnes. In spite of a recovery in demand, we believe that the rate of recovery would be slow in 2H2020. We believe that Chinese consumers would take time to revert to their pre-Covid-19 eating and shopping patterns. Also, China is resuming purchases of soybeans as the African swine fever disease eases and as the country fulfils its phase 1 commitment with the USA. The increase in soybean supply in China is expected to result in higher supply of soybean oil and lower demand for palm oil. China’s palm imports dropped by 34% YoY in 1Q2020 in contrast to the 6.2% increase for soybean imports.

• On a positive note as business activities start picking up ahead of the Deepavali festivities in October, we reckon that India’s palm demand would rise. India is expected to buy palm oil in crude form from Indonesia and Malaysia Also, India has imposed more restrictions on the imports of palm in refined form to protect its edible oil processors.

Source: AmInvest Research - 23 Jun 2020