NEUTRAL on the sector with selective BUYs. We believe that CPO prices will be resilient in 1H2018 supported by a slower growth in palm oil production. We have assumed an average CPO price of RM2,650/tonne for Malaysia in 2018F, which is slightly weaker than the RM2,700/tonne assumed for 2017E. We think that supply of palm oil would continue to rise in 2018F but at a lower magnitude compared with 2017E. We reckon that CPO output may be lower YoY in 1H2018 before picking up in 2H2018.

As CPO prices are forecast to be relatively flat in 2018F, net profit of the plantation universe is expected to be supported by expansions in FFB production. Increases in mature areas are expected to drive FFB output growth more than enhancements in FFB yields. Younger plantation companies are expected to record stronger increases in mature areas compared with their larger counterparts as they were more aggressive in new plantings of oil palm in Indonesia in the past years.

We have BUYs on Genting Plantations (GenP) and TSH Resources. We have assumed increases in FFB production of 10.5% for GenP (FY17F: 18%) and 7% for TSH (FY17F: 12%). We have fair values of RM11.50/share for GenP, based on a FY18F PE of 27x and RM1.90/share for TSH, based on a FY18F PE of 20x. We applied a premium to GenP's valuation on the back of its operational efficiencies, clean balance sheet and young oil palm trees in Indonesia.

• We are neutral on the sector as there is a balance between the positive and negative factors.

• Positive factors:

1. Slowing industry palm production in 2018F to support CPO prices? Tree stress usually affects oil palm trees after a bumper year of harvest. After achieving a CPO production growth of 26.9% in 1999, Malaysia's CPO output inched up by a mere 2.7% in year 2000 as average FFB yield fell from 19.3 tonnes/ha to 18.3 tonnes/ha. A 12.1% increase in CPO production in 2003 was followed by a slowdown to 4.7% in 2004 as FFB yield softened from 19.0 tonnes/ha to 18.6 tonnes/ha. In 2011, after an 11.3% climb in CPO production, CPO output growth slid by 0.7% in 2012 as FFB yield eased from 19.7 tonnes/ha to 18.9 tonnes/ha. Currently, Oil World is forecasting CPO production to rise by 5.6% (2017E: 12.6%) to 20.6mil tonnes in Malaysia and 6.1% (2017E: 11.8%) to 38.2mil tonnes in Indonesia in 2018F.

2. Soybean prices have bottomed. Although it is not new that there would be a soybean glut in 2018F, demand and supply projections on soybean are not bearish. Hence if the weather turns unfavourable in the US, there may be a tightness in supply instead of a glut. Currently, the USDA is forecasting global soybean inventory to inch up by a mere 1.3% from 94.86mil tonnes in 2016/2017E to 96.05mil tonnes in 2017E/2018F. Global soybean production is estimated to be flat at 347.9mil tonnes in 2017F/2018F.

Negative factors:

1. China and India’s demand for palm oil may decline in 2018F. China's demand for palm oil may taper off in 2018F after improving in 2017E. China's palm imports expanded by 7.5% YoY in 8M2017. The country is expected to have sufficient palm oil inventory by the end of the year. Palm oil inventory at the major ports in China stood at 403,500 tonnes as at 11 October 2017 compared with the three-year average of 489,235 tonnes. India's demand for palm oil is expected to decline in 2018F due to the hike in import duties for palm products in August 2017 unless there is a shortfall in domestic production resulting from unfavourable weather. Currently, India has enough inventory of edible oils. Inventory of edible oils at the major ports stood at 2.47mil tonnes as at August 2017 vs. the three-year average of 2.1mil tonnes. India's imports of Malaysia's palm oil declined by 28.7% YoY in 9M2017 and 23.5% YoY in 2016.

2. Slowing biodiesel consumption? Off-take of palm oil from the biodiesel segment in Indonesia is not expected to be exciting in 2018F. There is little incentive for biodiesel consumption as petrol prices are low and subsidies are insufficient. The Indonesia Palm Oil Association estimates biodiesel consumption to be 2.6mil tonnes in 2017F vs. 2.9mil tonnes in 2016.

PE valuations are close to historical highs. Plantation companies (ex-Felda Global Ventures) in our stock universe are currently trading at FY18F PE multiples of 23x to 24x. Historically, the highest level of PE valuation of large-cap plantation companies is 27x. We have HOLD recommendations on large caps such as KLK, IOI Corporation and Sime Darby as their valuations are more demanding than the medium and small-caps. The large plantation companies are 27% to 33% more expensive than the likes of IJMP and TSH.

Source: AmInvest Research - 23 Oct 2017