• The 3Q18 earnings season saw only Sarawak Plants beat our expectation, whilst 8 (or 72%) out of 11 companies in our coverage came in below.

• Aggregate FFB production of companies in our coverage rose by an average 3% in YTD Sept 2018, which is below our initial forecast of 11%.

• Risk of poor earnings in 4Q18 remains high as CPO price could remain weak and FFB production unlikely to grow higher than last year.

• We now Underweight the sector against the likely scenario that a lower ASP of palm products would continue to be a risk to earnings.

Earnings mostly were below estimates

The recently concluded corporate earnings seasons was disappointing for plantation companies. Among 11 plantation companies under our coverage, only one beat our expectation, namely Sarawak Plantation (SPB). A total of 8 companies missed our earnings targets, whilst Sarawak Oil Palm (SOP) and TSH Resources (TSH) came-in within our expectation (Table 1). Earnings were generally lower QoQ/YoY/YTD mainly due to: 1) Lower palm product price realized, 2) Lower production and sales volume transacted; and 3) Huge one-off impairments and higher net foreign exchange losses on USD denominated borrowings.

FFB production rose by an average 17% qoq but fell by 0.1% yoy

From our analysis, companies with higher percentage of older and/or immature estates tend to register sharper declines in FFB production – with IOI, HAPL and FGV’s yoy FFB production slumping 18%, 15% and 12% respectively (Table 2). However, companies with young oil palm trees and exposure in Indonesia (TSH, GENP, and IJMP) as well as land-bank in Sarawak (SOP, SPB and THP) recorded relatively higher growth in FFB production.

What to expect in Q4 2018?

We believe plantations companies are at risk of further earnings disappointment in 4Q18 as CPO price realized could hover below RM1,900/MT and production unlikely to grow higher than last year. We forecast earnings growth for companies under coverage to be a mixture of positive and negative growth in 2019, averaging at -5.5% yoy (excluding FGV with growth >100%).

Underweight on sector

We now recommend an Underweight on the sector. We believe 4 primary issues will likely play out for 2019, hence exerting downward pressure on CPO price; namely 1) sluggish export demand, 2) higher CPO inventory due to ample supply and expected pick-up in demand in other oil seed substitutes, 3) bearish soybean and soybean oil prices – CPO losing its competitiveness, and 4) escalating trade tension between US and China – further dampening vegetable oil prices therefore impacting CPO price. Consequently, we revised our average CPO price forecast for 2019 to RM2,280/MT from RM2,450/MT previously. The average CPO price YTD Nov 2018 is RM2,275/MT, and we expect the average of 2018 at RM2,300/MT.

Valuation-wise, the Plantations Index currently trades at 30x, above its 5-year historical average PER of 25x. We have Hold on KLK (TP: RM24.25), Batu Kawan (TP: RM17.28), HAPL (TP: RM1.68), TSH (TP: RM1.07), GENP (TP: RM10.33), IOIC (TP: RM4.20), SOP (TP: RM2.46) and FGV (TP: RM0.98). Sell on IJMP (TP: RM1.66) and Sarawak Plant (TP: RM1.41) whilst a non-rated for TH Plant.

Q3 2018 Earnings disappointment

Among the 11 plantation companies under our coverage, only one beat our expectation, SPB. Two companies, SOP and TSH came-in within our expectation. Importantly, 8 companies or 72% of our coverage missed our targets (Table 1). Additionally, 4 out of 11 companies reported better qoq performance mainly due to higher production and volume transacted that helped to mitigate a weak ASP of palm products. For TSH, besides a higher FFB and CPO production, the qoq earnings growth was due contribution from other segment, i.e. cocoa products due to better cocoa products prices.

Source: BIMB Securities Research - 5 Dec 2018