We reiterate our positive view on HSP’s near term earnings outlook, on the back of improving palm oil price sentiment and mild FFB production growth. We maintain our BUY rating on HSP with a higher TP of RM2.14 (from RM1.68 previously), as we raise our net profit forecasts, roll forward our valuation base year (from FY20 to FY21), and shift our valuation methodology to sum-of-parts valuation.

We reiterate our positive view on HSP’s near term earnings outlook, on the back of improving palm oil price sentiment and mild FFB production growth.

High earnings sensitivity to CPO price movement. HSP’s net profit plunged 98.8% to RM0.3m in 9M19, due mainly to lower realised palm product prices (CPO: -16.1%; PK: -36.6%). We expect its earnings performance to improve significantly from 4Q19 onwards, driven mainly by the sharp recovery in CPO prices since Oct-19. Based on our estimates, every RM100/mt change in our CPO price assumption will change our FY20 net profit forecast by RM11.6m (or 21.2%).

FFB output growth guidance of 3-3.6% in FY19-20. FFB output grew 6% to 617.6k tonnes in 11M19, and management guided that it remains on track to achieve its FFB output growth guidance of 681k tonnes in FY19. Despite having anticipated palm stress (which will have an impact on its FFB output, management feels confident that FFB output will remain on uptrend in FY20 (albeit at a slightly milder growth rate of 3%), supported by an additional 1,000 ha of planted area moving into mature bracket. In our forecasts, we are projecting FFB production to grow by 3.7% and 2.1% to 681.5-695.5k tonnes in FY19-20.

Production cost to remain flattish. Despite lower PK credit, CPO production cost declined by 2% to RM1,559/tonne in 9M19, due to higher CPO production. Management guided that CPO production cost will remain at below RM1,600/tonne in FY20, after having reflected higher fertiliser cost.

Replanting to slow in FY20. We understand that replanting activities will slow to 500- 600 ha in FY20 (from 1,000-1,100 ha in FY19) before normalising back to ~1,100 ha from FY21 onwards.

3rd biogas plant to commission by end-FY20. We understand that HSP is currently constructing its 3rd biogas plant, and target for commissioning by end-FY20. Apart from offering energy cost savings, the commissioning of the biogas plant will generate a tax credit of RM5-5.5m to HSP (which we expect to be utilised by FY20-21, hence resulting in lower effective tax rate).

Forecast. We trim our FY19 net profit forecast by 32.5%, mainly to account for higher CPO production cost assumption. We raise our FY20-21 net profit forecasts by 1.8- 7.3%, mainly to account for lower effective tax rate assumption (arising from the completion of second biogas plant).

Maintain BUY, TP: RM2.14. We maintain our BUY rating on HSP with a higher TP of RM2.14 (from RM1.68 previously), as we raise our net profit forecasts, roll forward our valuation base year (from FY20 to FY21), and shift our valuation methodology to sum of-parts valuation (from P/E multiple previously, to better reflect HSP’s net cash position in our valuation methodology). Our SOP valuation on HSP comprises (i) 25x FY21 EPS of 7.9 sen (in line with our target P/E multiple for mid-cap upstream planters), and (ii) projected 14.1 sen net cash balance in FY19.

Source: Hong Leong Investment Bank Research - 20 Dec 2019