Upcycle in the making. We are upgrading the Plantation sector to Overweight on expectation of palm oil price entering a new three-year price upcycle, fuelled by increasing probability of a drought-inducing El Nino weather phenomenon. We believe Malaysia's already weak production may be aggravated by the onset of El Nino. We fear that this upcoming El Nino could be a severe one given that the last region-wide El Nino occurred from 1997 to 1998. We are upgrading KL Kepong, Astra Agro Lestari and Glenealy to Buys, and upgrade IOI Corp from Sell to Neutral. We now have Buy calls across the board, with the exception of IOI Corp. Our fair values are mainly pegged to a 16x CY13 PE. There is room for further an upward revision as the sector re-rates, bearing in mind that the sector used to trade in excess of 20x PE.

Biggest bang for the buck. While we have broad Buy calls, the stocks which could give investors the biggest bang for the buck are the companies which have plenty of young trees and are trading at inexpensive valuations such as SOP, Kencana Agri and BW Plantations. We also like Kulim, which is trading at less than 10x CY13 earnings after stripping out the 93 sen special dividend. We suggest having exposure to both Malaysian and Indonesian plantation stocks as we do not know at this point in time which country will be the worse-off from the impending drought.

If El Nino does not occur. We have been recommending the accumulation of high-quality growth stocks for some time and believe one should be positioned for the eventual slowdown or plateauing of Indonesia's production. Hence, if the El Nino does not take place or turns out to be a weak one, we still think this is still an opportune time to buy plantation stocks.

Raising average palm oil price to RM3,500 for CY13. We are raising our average palm oil price assumption for CY13 to RM3,500 per tonne, representing a 12.9% increase from our earlier assumption of RM3,100. Compared with the CY12 average of RM3,215 YTD, RM3,500 represents an 8.9% increase, which is consistent with what happened in 2006. However, unlike both the previous episodes, we believe the impact of El Nino will be immediate in the current scenario given that the trees in Malaysia are already experiencing stress due to dry weather in the past 2 to 3 months. This is evident from the recent emergence of two or three unopened 'spears' on oil palm trees.

Source: OSK