We expect FGV’s FFB and CPO production to continue to improve due to rising prime-matured palm-tree areas and lower production costs, offsetting the impact of a dip in CPO prices. Meanwhile, given the favourable raw material costs and strengthening of the RM, we look for continued improvement in the sugar division’s earnings, though there could be some downside risks from the start-up in the new refinery. FGV remains our top sector pick. Reaffirm BUY call and TP of RM2.26.

Higher Production and Lower Cost to Help Support Plantation Earnings

We expect FGV’s plantation division earnings to continue growing in 2018- 20E, on the back of a boost in FFB yields and CPO production, arising from an increasing prime-matured palm-tree area. We also expect improvement in production costs to offset the impact of a dip in CPO prices. Over the years, FGV’s palm-tree age profile has improved and currently its average palm-tree age stands at c.14.5 years. We expect FGV to be on track to achieve an ideal palm-tree age profile of 12-13 years by 2020 through an annual replanting programme of about 3-6% of its planted landbank.

Better Earnings Expected From Sugar But Cautious on New Refinery Risk

We expect subsidiary MSM (MSM MK, RM3.50, HOLD) to generate better earnings in 2018E given favourable raw material costs and currency factors, though we note there could be some downside risk from its new refinery.

Earnings Sensitivity

Based on our sensitivity analysis, a RM50-150/MT move in CPO prices could affect core EPS by 10-33% in FY18-20E. A swing in FFB yields by 0.25- 1.0MT/ha would impact 2018-20E core EPS by 2-11%, while a change in the oil-extraction rate (OER) of 0.25-1.0% would affect core EPS by 2-9%.

Reaffirm BUY Rating and Target Price of RM2.26

We reaffirm our BUY call on FGV and 12-month TP of RM2.26, based on an unchanged 25x PER on our 2018E core EPS. Key earnings drivers would be higher FFB and CPO production and a better contribution from the sugar business. We like FGV as its management team is focused on improving the core business and operations, and enhancing ROE of the business through capital and resource optimization. Downside risk: adverse government policy.

Younger Trees to Drive Production Growth

Stronger Growth Coming From Young Trees

FGV has been aggressive in their palm-oil replanting programme given that most of their palm trees are older. Over the years, the Group’s palm-tree age profile has improved and currently FGV’s average palm-tree age is approximately 14.5 years. We are of the view that FGV is on track to achieve an ideal palm-tree age profile of 12-13 years by 2020 through their annual replanting programme of about 3-6% of their planted landbank area. For 2017, FGV replanted about 10,675 ha of oil palm, representing about 3% of their total planted area.

FFB Yield Expected to Improve

FGV’s 2017 FFB production rebounded by 9% yoy to 4.26m MT. This was largely anticipated after the 2016 El Nino phenomenon affected production. We expect the Group’s FFB production to continue improving in 2018-20E by 3-11% yoy to 4.7-5.0m MT. The rise in FFB production is underpinned by: 1) higher prime matured estate areas (refer to Fig 2); and 2) improving FFB yields from 15.4 MT/ha in 2017 to 16.5-17.5 MT/ha in 2018-20E.

CPO Production to Grow in Tandem With FFB

In tandem with the higher FFB production, FGV’s 2017 CPO production increased by 11.9% yoy to 2.99m MT. FGV is the biggest CPO producer in Malaysia, accounting for about 15% of Malaysia’s 2017 total CPO production of 19.92m MT. We forecast FGV’s CPO production to continue to improve in 2018-20E by 3-8% yoy to 3.2-3.4m MT.

CPO Prices Likely to be Under Pressure

FGV’s average CPO prices went up to RM3,061/MT in 1Q17, the highest level in the past 5 years, and then proceeded to trend lower towards the end of end 2017 due to high stock levels in Malaysia (4Q17: RM2,723/MT; 2017: RM2,792/MT). We believe that 2018E CPO prices will likely be under pressure partly due to higher CPO production expectation in Malaysia, higher inventory levels as well as the strengthening of RM vs. the USD. At the moment, we maintain our CPO ASPs forecast at RM2,500-2,600/MT over 2018-20E.

Recertification of Palm-oil Mills for RSPO

As at end-2017, 8 out of 68 palm-oil mills of FGV have been recertified for RSPO. This allows the Group to produce 200,000 MT of Certified Sustainable Palm Oil (CSPO) and 22,000 MT of Certified Sustainable Palm Kernel Oil (CSPKO) and enable them to get a better rate for their certified sustainable palm-oil products. By end-2018, FGV expects to recertify another 28 of their palm-oil mills. FGV targets to recertify all of their palmoil mills by year 2021. FGV has also indicated that they will likely close down another 4 palm oil mills by end-2018, due to close proximity some of the mills location. With the closing down of these palm-oil mills, the processing cost is expected to decline as utilisation rate of other mills will likely improve.

Lower Cost as Production Improves

With the anticipated improvement in production processes, the average production cost for CPO is also expected to decline. We expect the cost of production to gradually decline to RM1,575/MT in 2018E and RM1,550/MT in 2019E from RM1,592/MT in 2017 (2016: RM1,595).

Better earnings expected from sugar business; new refinery is a wild card

Expanding Production Capacity…

FGV’s listed subsidiary, MSM Malaysia Holdings Berhad (MSM), is the leading refined-sugar producer in Malaysia with about a two-thirds domestic market share. MSM is expanding their annual production capacity from 1.1m tonnes to 2.2m tonnes by 1H18. Their 3rd sugar refinery plant is located in Tanjung Langsat, Johor, and this refinery is expected to cater mainly to the export market.

…could Potentially Drag Margins at the Initial Stage

MSM’s management intends to start off with a capacity of 700k MT and achieve a utilisation rate of 30-35% within a year (estimated 40% utilisation rate to break even at net profit level). Also, with the commencement of the 3rd sugar-refinery plant, MSM’s PBT margin could potentially narrow given that the exported sugar margin is lower at RM120-150/tonne as compared to the domestic margin of RM700-1,000/tonne.

Better Earnings Expected From Sugar Business in 2018E

We expect MSM to deliver better earnings in 2018E on the back of more favourable raw-material costs and currency factors (refer to Fig 7 below), though we note that there could be downside risk to earnings posed by the new refinery.

2018 Priorities

FGV Key 2018 Priorities

FGV’s strategic focus areas going forward include: 1) Operational excellence – i) worker-retention programme by building 527 blocks of new housing to accomadate 14,000 workers; ii) improving FFB production and reduce cost of production; iii) replant about 15,000 ha to improve age profile; iv) mechanization in harvesting and fruit collection to improve labour productivity; v) consolidate PK shell business for export market and improve shell recovery rate to 1.2%; vi) 28 mills to be ready for RSPO certification; and vii) rationalization of 4 mills to increase the mills’ utilisation rate and reduce processing costs. 2) Moving down the value chain – i) improve number of key wholesalers for cooking oil by 20% from the current base of 200 key wholesalers nationwide; ii) develop higher crop yields and quality oil-palm seeds through molecular genetics research; and iii) obtain kosher certification through kosherised fractionation system at its US-based oleo chemical plant. 3) Growth through portfolio balancing – i) potential value accretive land-bank expansion; ii) synergistic strategic alliances in key consumption countries; iii) commence operation of Johor sugar refinery by mid-2018; and i) grow logistics and support business capabilities to generate external opportunities. 4) Optimizing financial and human capital – i) divestment of noncore and non-performing assets/investments; ii) manpower optimisation and talent development; iii) enhance terms of existing JV agreements; iv) manage perception through engaging with stakeholders and intensify public relations.

Valuation and Recommendation

Increase in Production and Lower Cost Likely to Boost Earnings Growth

We expect FGV’s plantation division earnings to continue growing in 2018- 20E, on the back of a boost in the FFB yields and CPO production, arising from the increased level of prime-matured palm trees. An improvement in production costs is also expected to offset the impact of a dip in CPO prices. We expect earnings at the sugar division to improve in 2018E, backed by the low global raw sugar price expectations and strengthening of the RM. We also expect the logistics division to improve in tandem with higher tonnage carried and throughput handled by the Group’s transport operation in tandem with the increase in CPO production volumes.

Earnings Sensitivity on CPO ASP, Production and Yields

Similar to other plantation companies, FGV’s earnings are also affected by the movement in CPO prices, changes in FFB yields as well as the oil extraction rate. Based on our sensitivity analysis, a RM50-150/MT movement in CPO prices could potentially affect core EPS by 10-33% for

2018-20E. A change in FFB yields by 0.25-1.0MT/ha would potentially affect core EPS by 2-11%, while a change in the OER of 0.25-1.0% would impact core EPS by 2-9%. Please refer to Fig 10 below.

Reaffirm BUY Rating and TP of RM2.26; Our Top Sector Pick

We maintain our 2018-20E earnings. We reaffirm our BUY call on FGV and 12-month TP of RM2.26, based on a 25x PER applied to our 2018E core EPS. We expect FGV to generate relatively robust earnings growth over 2018-20E on higher FFB and CPO production, and a better contribution from the sugar business. We like FGV, our top sector pick, as management is focused on improving the core business and operations, and enhancing the ROE of the business through capital and resource optimization.

Downside Risks

Key downside risks include: 1) a weaker-than-expected recovery in the global economy; 2) lower vegetable oil and crude oil prices; 3) weaker-thanexpected FFB and CPO production; and 4) adverse changes in policies.

Source: Affin Hwang Research - 18 Apr 2018