• We believe that earnings of most plantation companies would be higher in 3Q2017 vs. 2Q2017 as expansions in palm production help offset lower CPO price. Also, manuring expenses may be lower in 3Q2017 as wet weather impedes fertiliser application.

• FFB production of the plantation companies under our coverage grew by 6.9% to 34.0% QoQ in 3Q2017. Exception was IJM Plantations (IJMP), which recorded a 7.0% QoQ decline in internal FFB output in 3Q2017. We believe that IJMP was affected by weak FFB yields in Sabah, resulting from the last leg impact of El Nino, which took place in year 2015.

• TH Plantations achieved the highest QoQ increase in FFB production in 3Q2017 while Genting Plantations registered the lowest positive growth.

• The 6.9% to 34.0% QoQ increase in FFB production in 3Q2017 is expected to help mitigate the impact of a weaker CPO price. According to MPOB, average CPO price edged down by 1.6% from RM2,723/tonne in 2Q2017 to RM2,681/tonne in 3Q2017.

• Comparing 9M2017 against 9M2016, upstream earnings are expected to grow by more than 20% underpinned by increased CPO price and production.

• FFB production of the companies in our stock universe climbed by 3.3% to 39.4% YoY in 9M2017 (calendar year). TSH Resources achieved the highest FFB output growth of 39.4% while Felda Global Ventures (FGV) recorded the lowest increase of 3.3%.

• FGV attributed its weak productivity to labour shortage. The group was short of about 8,000 workers. FGV recruited 1,200 workers in July and is expected to recruit another 6,800 workers by year-end.

• In terms of selling price, average CPO price (MPOB spot price) was RM2,852/tonne in 9M2017, 12.6% higher than the average price of RM2,534/tonne recorded in 9M2016.

• We believe that downstream (mainly refining and oleochemical activities) earnings would be more stable in 3Q2017. Although prices of raw material rose QoQ in 3Q2017, they were less volatile. This has made it easier for downstream companies to predict and source raw materials.

• Palm kernel oil (PKO) and palm stearin are used to manufacture oleochemicals. According to MPOB, average price of crude PKO was RM4,857/tonne in 3Q2017, 11.9% higher than the average of RM4,339/tonne in 2Q2017. Monthly price of crude PKO was the highest at RM7,774/tonne in January 2017.

• We expect earnings of the downstream units of Kuala Lumpur Kepong (KLK), IOI Corporation and Sime Darby to improve QoQ in 3Q2017.

• Recall that KLK recorded inventory write-downs of RM60.3mil in 2Q2017 while IOI registered a fair value loss of RM44.6mil on financial derivatives. Sime Darby's downstream unit chalked up a loss of RM49mil in 2Q2017 while its oleochemical joint venture, Emery Oleochemicals recorded an inventory write-down of RM39mil.

• Maintain Neutral on the plantation sector. We have BUYs on Genting Plantations, with a fair value of RM11.50/share and TSH Resources, with a fair value of RM1.90/share.

Source: AmInvest Research - 3 Nov 2017