Highlights 

Share  prices  retraced.  Since  our  sector  downgrade  (on  25 Aug  2014),  the  Plantation  Index  has  retraced  by  7% to 7,989 pts  (vs.  a  3.6%  decline  in  KLCI,  see  Figure  1),  narrowing the divergence  with  CPO  futures   and  exceeded  the  envisaged downside  risk  of  KL  Plantation  Index .  Recall on 25 Aug 2014, we  estimated  that  Plantation  Index  could  retrace  by  215  pts (or  2.5%)  to  8,375  pts,  assuming  a  correlation  of  0.92x between  CPO  price  and  Plantation  Index;  and  (2)  CPO  price to eventually  recover  to RM2,300/mt.

In  terms  of  individual  stock  performance  under  our  coverage, share  prices  have retraced by  0.6-10.8% within the same time frame  (except  for TSH  TSH,  see Figure 3)  and much nearer to our  TPs.  Thus,  we  believe  it  is  time  to  review  our  ratings  on the sector as well as stocks under coverage.

Worst  could  be  over.  While  we  are  keeping to the view that CPO  price  will  unlikely  recover  significantly  higher  from current  level  (given  the  economic  viability  of  biodiesel  amidst current crude oil price levels  as well as  the narrow discount on CPO  against  soy  oil),  we  believe  the  worst  could  possibly be over  for  the  sector,  as:  (1)  the  extension  of  zero  export  duty on  CPO  until  Dec -14  will  encourage  near-term  demand  for CPO;  (2)  seasonally  high  production  season  is  coming  to  an end;  and  (3)  we  are  still  retaining  our  positive  view  on  crude oil prices.  

Maintain  average  CPO  price  projections  of  RM2,400/mt  and RM2,300/mt for  2014 and 2015 respectively.

Given  the  more  commendable  valuations  and  the  absence  of significant  negative  sector  news  flows,  we  are  upgrading  our rating on  the  sector  from  Underweight  to  Neutral.  With  the exception  of  KLK  (which  recommendation  is  upgraded  from Sell  to  Hold,  with  unchanged  TP  of  RM20.41  following  the recent  share  price  correction),  recommendation  for  all  other stocks  under  our  coverage  remains  unchanged  (see  Figure 4).

Catalysts 

• I mplementation  of  higher  biodiesel  mandate  in  Indonesia  and Malaysia
• Weather  uncertainties  revisit,  which  would  result  in  supply distortion, hence boosting prices of edible oil

Risks

• Higher-than-expected  soybean  yield  and  soybean  planting, resulting in lower  soybean prices, hence prices of CPO
• India  imposes higher  import duty on CPO
• Escalating production  cost (in particularly, labour  cost)

Rating

NEUTRAL

• Positive  –  Long term sector outlook remains favourable
• Negatives  – Weak demand  and price outlook

Sector View

• For exposure, our top pick is IJM Plant (Hold; TP: RM3.52).

Source: Hong Leong Investment Bank Research - 21 Oct 2014