Highlights

Indonesia overtook Malaysia as the world’s largest CPO producer since 2006 due to its aggressive new planting activities whereby planted acreage has already surpassed Malaysia since 1997.

Going forward, we believe Malaysia will unlikely to reclaim its position in the upstream plantation segment from Indonesia, due to: (1) Limited arable land bank for oil palm plantations in Malaysia; and (2) Labour scarcity.

Given the limited scope of expansion for the upstream segment in Malaysia, coupled with aggressive downstream expansion plans by players in Indonesia, we believe capacity growth within the downstream segment in Malaysia will unlikely expand significantly.

The limited scope for upstream expansion in Malaysia has resulted in Malaysian companies redirecting their efforts and resources towards regional (and to a certain extent, international) expansion. As of end-2009, Malaysian companies already owned ~25% of total oil palm plantations in Indonesia. We believe the ownership will continue to rise, given the arable land bank for upstream plantation as well as the availability of labour there.

With the subdued CPO price outlook, we believe earnings growth of Malaysian plantation companies will be coming from: (1) CPO output growth, which in turn is driven by acreage expansion in Indonesia (which has more arable land bank for oil palm plantations relative to Malaysia); and (2) Downstream segment expansion in Indonesia that will complement the upstream plantation segment.

Catalysts

• China loosens its economic policy further; and
• More effective measures introduced by the Chinese authority to curb steel capacity.

Risks

• Overcapacity in China remains over the longer term;
• Volatile input prices, making the sector a play on short-term potential price trend; and
• Influx of steel at cheap prices.

Forecasts

Maintained.

Rating

Neutral 

Negatives – Overcapacity results in volatile earnings.

Positives – More commendable valuations.

Sector View

Maintain Underweight on the sector, given our less bullish view on CPO prices as well as the sector’s expensive valuations. Less exciting CPO price outlook aside, we see other positive angles in some plantation companies (which will cushion earnings from low CPO prices). For exposure in the sector, our top picks are CBIP (BUY; TP: RM3.42) and Genting Plantations (HOLD; TP: RM10.57).

Source:Hong Leong Investment Bank Research - 5 Jul 2013