We expect the CPO production to continue to improve in 2H18, but at a lower growth rate. As such, we cut our CPO price assumption for 2018-20E to RM2,350-2,500/MT from RM2,500-2,600/MT previously. The downtrend in CPO prices since end-2017 is negative for palm oil planters but we believe prices should recover, underpinned by demand for palm oil products in the food and energy industries, progress in biodiesel adoption globally and rising chances for El Nino to make an appearance. Following the changes in companies’ earnings and TPs, we downgrade IJM Plantation and Hap Seng Plantation to a SELL, and FGV to a HOLD. Our preferred sector exposure is Genting Plantation (BUY). We maintain our sector NEUTRAL rating.

Lowering CPO Production Growth Rate

Malaysia’s CPO production increased by 2.3% yoy to 8.92m MT in 1H18. We expect Malaysia’s CPO production to continue to improve in 2H18 and now forecast the production in 2018E to increase by about 1-2% yoy (2017: 19.92m MT, +15% yoy), lower than the earlier expectation for a 4- 5% yoy growth. 2H18 exports, in our opinion, should continue to be supported by the food and energy industries as well as potential increase in demand from China with the trade tension with the US due to the tariff on soybean products. Nevertheless, we think that CPO production would continue to rise and could come in higher than exports and consumption in 2H18. Hence, palm oil inventory in Malaysia is likely to stay above the 2.0m MT level for this year, but below end-Dec inventory of 2.7m MT in 2017.

Production of 8 Major Oils Expected to Improve

We expect the production of 8 major oils to increase in 2018/19E season. Despite growth in usage which is expected to be higher than the growth in production for 2018/19E, the stock-usage ratio for the 8 major oils is expected to remain flat at 14.2% partly due to the higher opening stocks.

Higher Production and Trade Tensions Pressuring Major Oil Prices

The price of vegetable oils, including palm oil, have been under pressure with the improvement in global production coupled with the trade tensions between the US and China. The 3-month CPO futures have been on a downtrend since late-2017, hitting a low of RM2,147/MT on 13 July 2018, the lowest level since Sep-15. Factoring in a CPO ASP of RM2,100- RM2,400/MT in 2H18, we now forecast a 2018 average CPO price of RM2,350/MT, down from RM2,500/MT previously. We expect CPO ASP to improve to RM2,400/MT-RM2,500/MT for 2019-20E with the improvement in demand for palm oil products, progress in biodiesel adoption globally and increasing chances for El Nino to make an appearance.

Cutting Earnings and Target Prices; Maintain NEUTRAL on the Sector

Following the cut in our CPO ASP and CPO production assumptions, we lower our core EPS forecasts for the plantation stocks under our coverage by 4-37% for CY2018E and 3-15% for CY2019E. As such our target prices for the plantation companies are lowered by 3-14%. Accordingly, we downgrade Hap Seng Plantation and IJM Plantation to a SELL from HOLD, and FGV to a HOLD from BUY rating. We maintain our HOLD rating on Sime Darby Plantation, KLK, Ta Ann and Jaya Tiasa; SELL rating on IOI Corp and WTK; and BUY rating on Genting Plantation (please refer to Fig.16 on page 11). We maintain our NEUTRAL rating for the sector.

Source: Affin Hwang Research - 10 Aug 2018