Investment Highlights

• Disappointing quarter. All of the plantation results were below consensus estimates. Most of the plantation earnings dived by more than 40% YoY in 1Q2018. The negative impact of the decline in CPO price could not be offset by higher CPO production in 1Q2018. According to the Malaysian Palm Oil Board (MPOB), average CPO price slid by 21.7% from RM3,152/tonne in 1Q2017 to RM2,467/tonne in 1Q2018. In contrast, FFB output of the companies under our coverage climbed by -4.9% to 32.3% YoY in 1Q2018.

• Earnings of most downstream units were also lower. The sterling downstream performances of most of the integrated plantation companies in 4Q2017 were not sustained in 1Q2018. KL Kepong’s oleochemical unit experienced lower selling prices in 1Q2018, which resulted in margin erosions. IOI Corporation suffered fair value losses on foreign currency forward contracts of RM7.2mil in 1Q2018 in contrast to gains of RM66.1mil in 4Q2017. On the flip side, Sime Darby Plantation sustained its EBIT QoQ in 1Q2018 on the back of positive refining margins and strong demand for high-value products.

• Higher CPO production costs in 1Q2018. We believe that CPO production costs of the plantation companies rose in 1Q2018 dragged by higher fertiliser costs and minimum wage in Indonesia. In addition, some plantation companies recorded increases in maintenance and upkeep costs in 1Q2018 as there were new areas coming into maturity. However, due to the surge in CPO production in 1Q2018, production cost on a per tonne basis of some of the plantation companies was relatively flat YoY in 1Q2018.

• Industry CPO production in 2H will exceed 1H. Several plantation companies have said that 2H will account for 55% to 56% of the full year’s CPO production while 1H will account for the balance 44% to 45%. Hence, CPO production is expected to continue to rise in 2H2018. The highest level of CPO output is envisaged to take place in either late 3Q or early 4Q. However comparing 2H2018 against 2H2017, there is a possibility that CPO production may decline as there was a strong recovery in yields in 4Q2017. Malaysia’s CPO output was 15.2% stronger in 2H2017 vs. 2H2016. Malaysia’s CPO production surged by 22.4% from 4Q2016 to 4Q2017.

• Earnings in 1H2018 to be weaker than 1H2017 due to lower price. So far, average CPO price (MDEX price) has been RM2,461/tonne in 1H2018, 16.2% weaker than the average price of RM2,938/tonne (MPOB price) recorded in 1H2017. As mentioned above, any increase in CPO production would not be able to make up for the fall in CPO price. Hence, we expect plantation earnings to be unexciting in 1H2018 against 1H2017. Comparing 2Q2018 against 1Q2018, we believe that plantation earnings may be lower due to softer CPO production and price. CPO production may be weaker in 2Q2018 vs. 1Q2018 as estate workers return home for the Hari Raya festivities. So far, average CPO price (MDEX price) has been slightly lower at RM2,413/tonne in 2Q2018 vs. RM2,490/tonne in 1Q2018.

• NEUTRAL stance on the sector. We are keeping our 2018F average CPO price assumption of RM2,450/tonne for Malaysia. If CPO production is weaker than expected in 2H2018, CPO prices may rise. For exposure to the plantation sector, we like Genting Plantations for its low production cost per tonne in Malaysia, young oil palm trees in Indonesia and recurring income from the Genting Highlands and Johor Premium Outlets.

Source: AmInvest Research - 6 Jun 2018