- Upgrade to Overweight. We are maintaining an average CPO price assumption of RM2,450/tonne for 2015F and RM2,600/tonne for Malaysia in 2016F. Although valuations of plantation companies are not cheap, we believe that the sector has been re-rated on the back of its decent operating profit margins, cash-flow generative nature and healthy balance sheet. Compared with other sectors, operating profit margins of most plantation companies are still attractive at more than 20% each in spite of weak CPO prices. This is with the exception of Felda Global Ventures. In addition, net gearing ratios of the plantation companies are comfortably below 100%. Based on consensus estimates, simple average PE valuations of the plantation sector are 22.0x for 2015F and 17.3x for 2016F.

- Flattish global soybean production in 2015F. After two years of growth, global soybean production is expected to be relatively flat at 317.3mil tonnes in 2015F/2016F versus 317.25mil tonnes in 2014/2015F. We believe that the bumper harvest in South America and huge stockpiles in US are known and have already been priced in by the market. Soybean output in the US is envisaged to decline by 3% to 104.78mil tonnes in 2015/2016F on the back of lower yields. Soybean production in Brazil, Argentina and Peru is forecast at 162.8mil tonnes this year compared with 161.5mil tonnes last year. However due to high carryover inventory from the previous season, global stockpiles of soybean are envisaged to rise 12.5% from 85.54mil tonnes in 2014/2015F to 96.22mil tonnes in 2015F/2016F. As US soybean crops are anticipated to be smaller this season, we believe that they would be more vulnerable to risk of unfavourable weather.

- CPO output to be soft in 2H2015? CPO production in Indonesia could fall short of expectations in 2H2015 due to the lagged impact of the dry weather, which took place in Kalimantan and certain parts of Sumatra in October 2014. As such, peak output season in Indonesia in 2H2015 may not be as strong as previous years. Kalimantan accounts for roughly 25% of Indonesia’s CPO production. Currently, the country’s CPO production is forecast to increase by 6.5% from 31mil tonnes to 33mil tonnes in 2015F. In the coming few years, there is a possibility that Indonesia’s CPO production could be lower-than-estimated not only because of the decline in new plantings but also due to unfavourable weather patterns. Over the past couple of years, the weather has been erratic as reflected in the bouts of dry weather and floods in Malaysia and Indonesia. This had resulted in FFB yields being affected every six months, 12 months and 24 months. In early-2014, Peninsular Malaysia, Riau and North Sumatra experienced dry weather. In 3Q2014, there was drought in Kalimantan. In 4Q2014, east coast of Peninsular Malaysia faced floods. In 1Q2015, North and Central Sumatra recorded dry weather for the second year running. This could affect the respective area’s FFB yields at end-2015F or early-2016F. In Malaysia, CPO production is estimated to improve by 0% to 2% in 2015F. Industry experts expect Malaysia’s CPO production to be 19.7mil tonnes to 20.1mil tonnes in 2015F (2014: 19.7mil tonnes). The country’s CPO output declined 6.3% YoY to 5.5mil tonnes in 4M2015.

- Our top pick is IJM Plantations (IJMP). We have BUY recommendations on IJM Plantations (IJMP), Genting Plantations, TSH Resources, KL Kepong and IOI Corporation. We have rolled over the fair values of the companies to reflect FY16F’s earnings. Our top pick is IJMP for its young oil palm trees and low net gearing of 13.0%. Although IJMP’s plantable reserves are depleting, we believe that the group’s profit growth would be supported by robust FFB production driven by new plantings of oil palm in the past couple of years. We forecast IJMP’s FFB production to expand by 9% to 10% in FYE3/16F. We have a fair value of RM3.90/share, which is based on FYE3/17F PE of 27x. Among the big-caps, our top pick is Kuala Lumpur Kepong (KLK). Apart from young oil palm trees in Indonesia, KLK also has the highest exposure to the upstream plantation business among the large planters.

Source: AmeSecurities Research - 15 May 2015