Investment Highlights

• Half of sector results were in line with expectations. About half of the results of plantation companies were within our expectations in 1Q2017 while the balance four fell short. These were Genting Plantations (GenP), IJM Plantations (IJMP), Felda Global Ventures (FGV) and Sime Darby. Recall that IJMP was affected by a high effective tax rate and fair value loss on plasma receivables in 1Q2017 while FGV's sugar division swung into losses on higher cost of raw sugar imports. FGV was also affected by impairments and provisions amounting to RM62mil. Sime Darby's industrial and property earnings were weak. GenP's margins were squeezed by sales of CPO to its downstream unit. The CPO was kept as inventory and not sold.

• FFB production rebounded YoY in 1Q2017 after being affected by El Nino in 1Q2016. All of the plantation companies in our stock universe recorded increases in FFB production of 17.2% to 30.5% YoY in 1Q2017. Exceptions were FGV, which registered a small growth of only 2.9% and TSH Resources, which chalked up a 9.5% YoY expansion in FFB output in 1Q2017. FGV expects a stronger recovery in FFB yields in 2QFY17 and 3QFY17. IJMP achieved the highest FFB growth of 30.5% YoY in 1Q2017. Comparing 1Q2017 against 4Q2016, FFB output fell by 9.6% to 23.6% due to seasonal reasons. The sharpest QoQ drop was recorded by GenP while the smallest decline was registered by Sime Darby. Due to the contraction in FFB production, it was not surprising that the sector's financial results surged YoY but declined QoQ in 1Q2017.

• Average realised CPO price climbed by more than 30% YoY in 1Q2017. Plantation companies under our coverage recorded average CPO prices of RM2,985/tonne to RM3,118/tonne in 1Q2017 compared with the average MPOB spot price of RM2,404/tonne in 1Q2016. Price disparity between CPO in Malaysia and Indonesia was stable in 1Q2017. The difference between IJMP's average realised CPO price in Malaysia and Indonesia was RM287/tonne in 1Q2017 against RM288/tonne in 1Q2016.

• Integrated players suffered squeeze in downstream margins. GenP was dragged by the refining division while integrated companies like IOI Corporation, Sime Darby and Kuala Lumpur Kepong (KLK) were hit by an increase in prices of palm kernel oil and stearin. This resulted in erosions in operating profit margin of the oleochemical divisions. Price of palm kernel oil (PKO) surged by more than 50% YoY in 1Q2017. PKO price was almost twice the price of CPO in 1Q2017. IOI's manufacturing unit recorded an EBIT margin of 1.7% in 1Q2017 vs. 5.7% in 4Q2016 while Kuala Lumpur Kepong's (KLK) manufacturing division registered an EBIT margin of 2.5%. Also, we believe that palm refineries in Malaysia faced challenging conditions in 1Q2017 as KLK's refining unit was in the red. Excluding fair value changes in derivatives, we reckon that either IOI's refining or oleochemical division may have recorded a loss in 1Q2017.

• 2Q2017 earnings to be higher than 2Q2016 but may be lower than 1Q2017. Earnings of plantation companies may be lower in 2Q2017 vs. 1Q2017 due to a weaker CPO price, which may not be offset by higher production. Average CPO price (MDEX spot price) has been RM2,740/tonne so far in 2Q2017. This is 14% lower than the RM3,152/tonne recorded in 1Q2017. We believe that CPO production would have to grow at a rate stronger than 10% for sector earnings to sustain QoQ in 2Q2017.

• Recovery in FFB production to drive sector profitability in 2017F. Assuming that average CPO price is flat or lower YoY in 2017F (2016 average CPO price: RM2,640/tonne), we believe that net profit of plantation companies would be driven by a recovery in palm oil production. Based on the numbers in 1Q2017, we reckon that plantation companies are on track towards achieving FFB production growth of more than 10% in 2017F.

MOSTLY IN LINE IN 1Q2017

• Upstream performed well in 1Q2017 on the back of higher prices and production

The upstream division of plantation companies performed well in 1Q2017 underpinned by the surge in CPO price, palm kernel price and FFB production. However, integrated companies experienced erosions in the operating profit margin of their oleochemical units due to an increase in palm kernel oil (PKO) and stearin costs. PKO price surged more than 50% YoY in 1Q2017. PKO price was almost twice the price of CPO in 1Q2017. EBIT margin of KLK's manufacturing unit was 2.1% in 1H2017 vs. 6.7% in 1H2016 while IOI Corporation's manufacturing unit recorded an EBIT margin of 2.8% in 9MFY17 against 7.6% in 9MFY16. Also, we believe that palm refineries faced challenging operating conditions in 1Q2017. KLK's palm refining units were in the red in 1Q2017. Excluding fair value gains on derivatives, we reckon that either IOI's oleochemical or refining unit may have recorded a loss in 1Q2017. Half of the results of plantation companies in our coverage were in line with our and consensus estimates in 1Q2017. Four planters i.e. Felda Global Ventures (FGV), Sime Darby, IJM Plantations (IJMP) and Genting Plantations (GenP) fell short. All plantation companies under our coverage recorded YoY improvements in net profit in 1Q2017, ranging from 67% to more than 100%. Exception was IOI, which registered a YoY decline of 32.2% in core net profit in 1Q2017 due to a 75.6% plunge in manufacturing earnings. Average realised CPO price climbed by more than 30% YoY in 1Q2017 while FFB production grew by 2.9% to 30.5%. Average CPO price (MPOB spot) was RM2,404/tonne in 1Q2016.

• Strong recovery in CPO production in 1Q2017

Plantation companies in our coverage recorded FFB production growth of 2.9% to 30.5% YoY in 1Q2017. Felda Global Ventures (FGV) recorded the lowest increase in FFB output in 1Q2017 while IJM Plantations (IJMP) achieved the highest growth. FGV expects the recovery in its FFB yields to be stronger in 2QFY17 and 3QFY17. The group thinks that its FFB production would peak in September. Plantation companies with Indonesia operations registered robust expansion in FFB production in 1Q2017. Exception was TSH Resources, which only chalked up a 5.7% YoY rise in FFB output in Indonesia in 1Q2017. TSH said that different areas have different rainfall patterns. Hence, the recovery in FFB yields may not be uniform across the board. We understand that TSH is currently seeing an uptick in FFB production in 2QFY17. IJMP's Indonesia unit recorded a 27.6% YoY climb in FFB production in 1Q2017 while GenP's FFB output surged by 48.0% in Indonesia. Excluding Wilmar International, plantation companies listed in Singapore, which have operations in Indonesia, achieved FFB production growth of 16.0% to 42.2% YoY in 1Q2017. The highest FFB increase of 42.2% was recorded by First Resources. Wilmar International recorded a mere 4.0% YoY improvement in its FFB production in 1Q2017. We attribute the low growth rate to aggressive replanting of ageing oil palm trees being undertaken by the group.

• Production cost per tonne declined YoY in 1Q2017

The YoY surge in FFB production led to lower production cost per tonne in 1Q2017. GenP recorded a production cost per tonne (all-in) of RM1,350 in 1Q2017 vs. RM1,730 in 1Q2016 while FGV's production cost (ex-mill) fell from RM1,824/tonne to RM1,739/tonne. TH Plantations (THP) registered a production cost (exdepreciation) of RM1,357/tonne in 1Q2017 compared with RM1,620/tonne in 1Q2016. We believe that production cost per tonne would decline or remain flat in FY17F as higher cost of wages is offset by economies of scale resulting from increased volume of production. We understand that fertiliser costs would be flat or lower in 2017F vs. 2016. Globally, fertiliser prices have been soft due to excess production capacity.

• Net gearing ratios of planters inched down in 1Q2017

Net gearing ratios of most plantation companies were lower as at end-March 2017 compared with end-December 2016. The fall in net gearing ratios was underpinned by the MYR, which closed stronger against the USD as at end-March 2017 vs. end-December 2016. Closing exchange rate was US$1.00: RM4.4255 as at endMarch 2017 vs. US$1.00: RM4.4862 as at end-December 2016. The stronger MYR resulted in lower value of USD borrowings when translated back into MYR. Plantation companies have a significant amount of USD loans as they are used to finance the operations in Indonesia. In our stock universe, IJMP has the highest exposure to USD as all of the borrowings are denominated in USD. However, we are not worried as the group's net gearing ratio is low at 29.7%. About 76.4% of IOI's borrowings are denominated in USD. IOI said that it has refinanced or swapped some of its USD loans into euro-denominated borrowings to diversify forex risks.

• Positive production outlook for 2017F

We believe that plantation companies are on track towards achieving a FFB production growth of more than 10% in 2017F. CPO production in Malaysia expanded by 18% YoY in 4M2017. Further enhancements in FFB output are expected to take place from August 2017 onwards. In the coming few months however, we reckon that FFB yields would take a breather due to seasonal reasons and the Hari Raya festivities. 2H is expected to account for 55% to 60% of full-year CPO production.

Source: AmInvest Research - 5 Jun 2017