Investment Highlights

• NEUTRAL. We are neutral on the plantation sector in 1H2022 as ESG issues are expected to suppress valuations and share price performances. In addition, we believe that CPO prices would decline in 2022F dragged by softer soybean oil prices and higher palm production in Indonesia and Malaysia. We have assumed an average CPO price realised of RM3,000/tonne for the companies in our coverage in 2022F vs. RM3,500/tonne in 2021E (2021E average MPOB spot price: RM4,400/tonne). The average CPO price realised is expected to be lower than spot prices due to Indonesia’s CPO export tax and levy.

• No BUYS. We do not have BUYs in the plantation sector. However, for investors who would like exposure to palm oil, we would recommend Kuala Lumpur Kepong (KLK) as the resilience of the group’s downstream operations would help cushion softer palm product prices. Also, the acquisition of IJM Plantations is expected to improve the age profile of KLK’s oil palm trees in Indonesia. The average age of IJMP’s oil palm trees in Indonesia is about six to seven years old currently vs. KLK’s 12 years (excluding IJMP). We have a fair value of RM21.85/share for KLK.

• Sector earnings may decline in 2022F due to higher fertiliser costs and lower prices. The prices of various types of fertiliser such as potash and urea have climbed by more than 30% driven by positive demand and lower supply. Global supply of fertiliser has been affected by sanctions in Belarus and shutdown of plants in Europe as they were hit by high gas prices. The climb in fertiliser costs may result in a 10% to 20% rise in production cost per tonne in 2022F. The all-in production cost of some companies may exceed RM2,000/tonne in 2022F from about RM1,800/tonne currently.

• ESG is a drag. The ESG issues affecting the palm oil sector in Malaysia are mainly greenhouse gas emissions and alleged forced labour conditions. The ban on the Malaysian palm products of FGV Holdings and Sime Darby Plantation (SDP) in the USA has not been lifted yet pending the submission of labour audit reports by the companies. Although the US is not a large export market for Malaysia, the ban has hurt the credibility of the companies and raised the risk that European countries may follow the example of the US Customs and Border Protection. In the past, the large-cap plantation companies traded at PEs of 27.0x to 30.0x. Currently, they are trading at 18.0x to 20.0x. This implies a valuation discount of 33% due to ESG.

Supply Factors

• Malaysia’s CPO production to recover in 2022F. We believe that CPO production in Malaysia would recover in 2022F after declines of 3.6% in 2020 and 5.0% in 2021E. We reckon that the return of 32,000 foreign workers and sufficient rainfall in 2021E would improve FFB yields in Malaysia in 2022F. Assuming average FFB yield rises to a modest 17.5 tonnes/ha in Malaysia in 2022F from an estimated 16.7 tonnes/ha in 2021E (based on mature areas of 5.3mil hectares), Malaysia’s CPO output would be 18.7mil tonnes in 2022F (2021E: 18.1mil tonnes). Currently, Oil World expects Malaysia’s CPO production improve by 1.1mil tonnes in 2022F while Indonesia’s CPO output is envisaged to be 1.7mil to 1.9mil tonnes higher.

• More foreign workers to enter Malaysia in 2022F? About 32,000 foreign workers were allowed to return to Malaysia in stages from mid-October 2021 onwards. An industry player said that the first batch of foreign workers may arrive in December 2021. According to the Malaysian Estate Owners Association, the shortage of harvesters has resulted in a loss of 3.4mil tonnes of CPO and 857,000 tonnes of palm kernel per year.

• Indonesia’s CPO output to be higher in 2022F. We think that Indonesia’s CPO production would continue to increase in 2022F even after the bumper harvest in 2021E. The rise in CPO output in 2022F is expected to be underpinned by a continued recovery in FFB yields as the lagged impact of 2019’s haze dissipates. Currently, plantation companies in our coverage expect their Indonesian operations to register high single-digit % increases in FFB production in 2022F. Presently, Oil World expects Indonesia’s CPO output to improve between 3.8% and 4.2% to a range of 47.0mil to 47.2mil tonnes in 2022F (2021E: 45.3mil tonnes).
• Global soybean production to increase by 4.2% in 2021E/2022F. Currently, the USDA forecasts global soybean production to increase by 4.2% to 381.8mil tonnes in 2021E/2022F. Global inventory of soybean is envisaged to rise to 102.0mil tonnes in 2021E/2022F from 99.8mil tonnes in 2020/2021E. The expansion in global soybean production in 2021E/2022F is anticipated to be driven by a 4.9% increase in output in the US and 4.3% rise in production in Brazil.
• US soybean inventory to climb by 32.7% to 9.3mil tonnes in 2021E/2022F on the back of higher output. The 4.9% increase in US soybean production in 2021E/2022F is expected to be underpinned by higher planted areas and yields. The USDA estimates planting areas of 87.2mil acres in 2021E/2022F vs. 83.4mil acres in 2020/2021E. US soybean yields are envisaged to be 51.2mil bushels per acre in 2021E/2022F compared with 51.0xmil bushels per acre in 2020/2021E.

Demand Factors

• India’s palm demand may ease in 2022F after huge purchases in 2021E. India’s inventory of edible oils at the ports and pipelines stood at 1.7mil tonnes as at 1 November 2021 vs. 1.6mil tonnes a year ago. Average monthly stockpiles were 1.8mil tonnes in 11M2021. India’s palm imports may exceed 8.0mil tonnes in 2021E vs. 6.4mil tonnes in 2020. Currently, the import duties on CPO and crude soybean oil are 8.25% and 5.5% respectively. On a negative note, we reckon that as prices of vegetable oils decline in 2022F, there is risk that the India government may raise import duties. The India government reduced the import duties on vegetable oils in September and October 2021 to mitigate inflationary pressures. Malaysia’s palm exports to India surged by 48.1% YoY to 3.2mil tonnes in 11M2021. India accounted for 22.8% of Malaysia’s palm exports in 11M2021.

• China’s palm demand may soften in 2022F. Like India, we reckon that China has ample reserves of vegetable oils after large purchases of palm products from Indonesia and Malaysia in 2021E. Hence, there is a possibility that China may switch back to soybean in 2022F from palm oil as its hog population increases. China’s palm imports rose by 4.4% YoY to 4.21mil tonnes in 11M2021 compared to a 5.5% decline in soybean imports. Malaysia’s palm exports to China fell by 33.2% YoY to 1.7mil tonnes in 11M2021, implying that China bought more palm oil from Indonesia during the period.

• EU palm imports are expected to fall in 2022F. The EU is expected to phase out the use of palm biodiesel in the transportation sector to zero from 2025F to 2030F. Some countries in the EU such as Belgium and France had already banned palm biodiesel ahead of the EU’s deadline of 2030F. Germany will ban palm biodiesel in 2023F. Currently, the use of palm biodiesel is capped at 2020’s level from 2021F to 2024F. About half of palm imports are used to produce biodiesel in the EU. The EU accounted for 10.4% of Malaysia’s palm exports in 11M2021. Malaysia’s palm exports to the EU declined by 18.2% YoY to 1.5mil tonnes in 11M2021.

• Indonesia’s B30 biodiesel policy is ongoing although there are occasional funding issues. Indonesia’s biodiesel consumption is expected to increase to 10.15mil kiloliters (8.8mil tonnes) in 2022F from 9.4mil kiloliters (8.2mil tonnes) in 2021E. Transportation activities in Indonesia are envisaged to recover in 2022F after being affected by lockdown measures in 2021E. The risk is a lack of monies in the Estate Crop Fund, which is used to subsidise biodiesel. So far, the Indonesia government has been raising the CPO export tax and levy to finance the Estate Crop Fund. Indonesia was supposed to implement B40 in 2021E but this has been postponed indefinitely due to Covid-19 and the surge in the price of CPO. Indonesia is currently running tests and trials on B40.

• Peninsular Malaysia to implement B20 in 2022F. Malaysia is anticipated to implement the B20 biodiesel programme in Peninsular Malaysia at the end of 2022F.Hence, the impact of B20 on palm inventory would only be felt in 2023F. B20 is estimated to absorb about 1.26mil tonnes of CPO per year. B20 was implemented in Sarawak and Sabah in September 2020 and January 2021 respectively. Currently, B10 is being implemented in Peninsular Malaysia.

Source: AmInvest Research - 28 Dec 2021