Highlights

• Despite high production season in 3Q15, pure upstream players are likely to report flat or weaker yoy net profit in 3Q15 as the growth in production will be largely offset by the decline in average CPO prices (-6.7% qoq, -7.3% yoy).

• Sabah-based companies such as IJM Plantations (IJMP) and TSH Resources are likely to be underperforming as compared to their peers as their production contracted 8-22% yoy (down 0.5-4.7% qoq) affected by the lagged impact from 1H15’s dry weather in Sabah. However, IJMP’s 2QFY16 net profit would be partly supported by the drawdown of inventory built up in previous quarter.

• Sime Darby (SIME) has reported double digit yoy growth in FFB and CPO productions. This is likely coming from the incorporation of production from New Britain Palm Oil that it has acquired recently while its Malaysia and Indonesia FFB productions were up by 1% and down 12% yoy respectively. However, we believe that SIME’s earnings will continue to be dragged by its industrial division.

• Earnings likely to be distorted by currency depreciation. The rupiah has depreciated by 9.9% qoq (-20.2% yoy) against the US dollar while the ringgit has depreciated by 16.5% qoq (- 34.0% yoy) against the US dollar in 3Q15. The translation gains or losses arising from the currency depreciation would affect companies with exposure to Indonesia rupiah- and US dollar-denominated loans.

• Outperformers likely to come from integrated players such as IOI Corporation (IOI) and Kuala Lumpur Kepong (KLK). Refining margin tends to be better in 2H given more CPO supplies in the market. Also, IOI and KLK have exposure to oleochemical business, which is commanding decent margin, as they focus more on niche and higher-margin products.

Catalysts

• Implementation 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

Positives

• Long term sector outlook remains favourable.

Negatives

• Weak demand and price outlook.

Top picks

• CBIP (BUY; TP: RM2.10)

Source: Hong Leong Investment Bank Research - 4 Nov 2015