We anticipate CPO price to remain at elevated levelsin the near term, and to trend down more noticeably in 2022, on the back of better vegetable oil supply prospects amidst the absence of fresh demand catalyst in 2022. We raise our CPO price assumptions in 2021-22 to RM3,800/mt and RM2,900/mt. Post revisions in earnings (largely to reflect the upward revision in our CPO price and output assumptions) and TPs, ratings for all plantation stocks remain unchanged. While we maintain the view that current high CPO price will not sustain over the longer term, we upgrade the sector to OVERWEIGHT, as we believe a re-rating is warranted on the sector’s palatable valuations and good near term earnings prospects (arising from elevated CPO prices). Our top picks are IOI Corp (BUY; TP: RM4.44), KLK (BUY; TP: RM25.33), Sime Darby Plantation (BUY; TP: RM4.99) and TSH Resources (BUY; TP: RM1.31).

Near-term CPO price to remain elevated. Tight inventory level of major vegetable oil (arising from weak output), and the onset of La Nina (which will curb soybean output in South America), will remain supportive for CPO price at elevated levels in the near term (possibly until end-2021).

Beyond 2022… Better vegetable oil supply prospects (in particular, soybean and palm oil) amidst the absence of fresh demand catalyst will likely result in weaker CPO price in 2022. For palm oil, we believe Malaysia’s vaccination target (80% of the population by end-Oct 21) will see reopening of more economic and social sectors, which will provide a glimmer of hope in easing the labour shortfall issue in Malaysia, hence resulting in a recovery in palm oil output in Malaysia. Despite the downward revision in soybean output estimate in US, we note the revised estimate of 4.34bn bushels is still c.5% higher than 4.14bn bushels of soybean produced in 2020/21.

CPO price forecasts raised in 2021-22. We raise our CPO price assumption for 2021 by RM600/mt to RM3,800/mt, mainly to reflect (i) the strong CPO price registered YTD (RM4,211/mt), and (ii) supply tightness in major vegetable oils, which will likely persist into the next few months. We raise our CPO price assumption for 2022 by RM100/mt to RM2,900/mt (from RM2,800/mt), as we anticipate supply and stock level of vegetable oil to gradually return to normalcy by then. CPO price assumption for 2023, on the other hand, remains unchanged at RM2,800/mt.

Changes in TPs and rating. We revise our TPs on plantation companies under our coverage by -5.1% to 5.6%, to reflect the upward revision in our earnings forecasts and a downward revision in P/E multiple for the sector (by 2x P/E multiples) to reflect ongoing ESG concerns on the sector. Ratings, on the other hand, remain unchanged for individual stocks.

Disconnect between performances of share price and CPO price due to ESG concerns. Despite recent recovery in share prices, share price performance of plantation companies (represented by KL Plantation Index) still lags behind CPO price rally, due to lingering ESG concern within the sector and doubts on sustainability of CPO price. We believe the concerns on ESG issues have already been reflected in the sector’s valuations, as (i) most players (particularly, larger sized players, which have been in the limelight amidst ESG issues) have been putting efforts in rectifying these ESG issues, and (ii) foreign shareholdings are at multi-year low level.

Upgrade to OVERWEIGHT. While we maintain the view that current high CPO price will not sustain over the longer term, we upgrade the sector to OVERWEIGHT (from Neutral) as we believe a re-rating is warranted on the sector’s palatable valuations and good near term earnings prospects (arising from elevated CPO prices). Top picks are IOI Corp (BUY; TP: RM4.44), KLK (BUY; TP: RM25.33), Sime Darby Plantation (BUY; TP: RM4.99) and TSH Resources (BUY; TP: RM1.31).

Source: Hong Leong Investment Bank Research - 7 Sept 2021