We are upgrading plantation sector call to NEUTRAL (from UNDERWEIGHT) as we believe that the worst should be over for CPO prices. Malaysia’s palm oil inventory level for Apr-13 declined 12% MoM to 1.93m mt. The data was 6% below the consensus estimate of 2.06m mt as production growth was surprisingly small at only 3% MoM to 1.37m mt. Looking forward, we believe that the stock level could fall 5% MoM to 1.84m mt by May-13. The trend of declining inventory is supportive to CPO prices. In addition, we think that the strong liquidity in the local market should neutralise the negative impact from the expected weak earnings results of plantation companies out this month. There are no changes to our CY13-CY14 average CPO price forecasts of RM2,500/mt-RM2,700/mt. We are rolling over all our valuations to CY14E EPS (from CY13E EPS). Hence, we have upgraded SIME (New TP: RM9.80; Old TP: RM8.82), IOICORP (New TP: RM5.40; Old TP: RM4.34), KLK (New TP: RM21.86; Old TP: RM19.30), FGVH (New TP: RM5.00; Old TP: RM4.00), GENP (New TP: RM9.00; Old TP: RM7.60), IJMP (New TP: RM3.38; Old TP: RM2.75) and TAANN (New TP: RM3.55; Old TP: RM2.84) to MARKET PERFORM ratings (from UNDERPERFORM previously). TSH meanwhile has been upgraded to an OUTPERFORM (New TP: RM2.44; Old TP: RM2.00). We are maintaining our previous OUTPERFORM rating on PPB (New TP: RM15.20; Old TP: RM15.00) and MARKET PERFORM rating on UMCCA (New TP: RM7.60; Old TP: RM6.70).

CPO prices may have bottomed. We believe that the worst should be over for CPO prices as a sustained inventory decline should lend the prices strong support. In Apr-2013, Malaysia’s stocks level declined 12% MoM to 1.93m mt and this was 6% lower than the consensus estimate of 2.06m mt. Production turned out to be lower than expected as well as it rose only 3% MoM to 1.37m mt due to an unexpected decline of 2% MoM to 454k mt in Sabah’s production. Looking ahead, we expect the May-13 inventory to decline by 5% MoM to 1.84m mt as the total demand (export + local disappearance) of 1.59m mt should exceed the total supply of 1.50m mt (local supply + import). This would be supportive to CPO prices.

Strong liquidity to neutralise the negative impact from upcoming weak results. Recall that in our post-GE Investment Strategy published on 6 May 2013, we had mentioned that the local banking system was flushed with approximately RM310b of excess liquidity. This amount of excess liquidity would be able to absorb almost all the free floats of the local equity market. As a result, we believe that any significant sell-down in the shares of local plantation companies due to their expected weak earnings in the May result season may be viewed by long term funds as an opportunity to accumulate the shares instead.

Rolling over our valuation to CY14, which assumed better CPO prices of RM2,700. We are rolling over all our valuations for the plantation companies to CY14 EPS (from CY13 EPS). As we expect CPO prices to recover to RM2700/mt in 2014 as crude oil prices recover, the CY14E earnings outlook would be generally better. Note that our Fwd. PERs remain unchanged for all the planters except for TSH, where we have reduced its Fwd. PER to 12.9x (from 16.3x) as we believe that the company’s FFB growth should decline to below 20% from CY14 onwards. Our new 12.9x Fwd. PER is based on a 5-year Average Fwd. PER while our previous Fwd. PER of 16.3x was based on a +1.0 Standard Deviation of the same above.

Upgrade to NEUTRAL, prefer PPB and TSH. Among the big caps, we continue to like PPB as its earnings are likely to register solid YoY growth in line with the good earnings from Wilmar (where its core earnings rose +53% YoY to USD314m). Note that the associate income from Wilmar contributed 75% to PPB’s earnings in FY12. On the other hand, we think that the other big cap planters should see their earnings decline YoY in their upcoming results due to the lower CPO prices YoY. For mid-caps, we like TSH as its superior FFB growth of 44% in 1Q13 may protect its earnings. In addition, the company’s earnings contribution from its joint-venture with Wilmar in the Sabah refineries should help it perform better YoY. All in, we believe TSH’s earnings should outperform the other mid-cap planters as we expect its earnings to decline a lesser 10% YoY as compared to the likely decline of more than 15% YoY for the other mid-cap planters.

Source: Kenanga