We maintain our sector call at OVERWEIGHT as we expect CPO prices in CY2014 to rise to an average of RM2800/mt or 17% higher than the expected CY2013 average of RM2400/mt. Our bullish view on CPO prices are premised on: (i) resilient demand from the Indonesian biodiesel industry so far, (ii) continued decline of stocks level in Malaysia in the near-term, and (iii) impact from QE tapering, which is actually positive to CPO prices. In addition, we also expect a good set of 1Q14 results due May-2014 as average CPO price has gained 15% YoY in 1Q14.

In our view, the current valuations of planters are still undemanding as their Fwd. PERs are trading in the range of Average to +0.5 Standard Deviation (SD) above its historical Fwd. PE. As we expect street consensus to upgrade their earnings forecasts, we believe that planters deserve +1.0SD valuation. Although current CPO price of around RM2650/MT is close to the consensus target of RM2675/MT, we maintain our bullish view on CPO prices. Note that demand for palm oil should increase in 2Q14 due to restocking activities ahead of Hari Raya festival in July.

Our top pick for the sector is TSH (OP; TP: RM4.10) due to its superior FFB growth which will provide additional boost to earnings growth in addition to the positive CPO price prospects. Recall that its FY13 FFB output growth of 28% YoY to 542,951 mt is the strongest among planters under our coverage. We also have OUTPERFORM on SIME (TP: RM10.00), IOICORP (TP: RM5.15), KLK (TP: RM26.10), PPB (OP; TP: RM17.00), IJMP (TP: RM3.80), TAANN (TP: RM5.00) and CBIP (TP: RM4.42). Maintain MARKET PERFORM for FGV (TP: RM4.75), GENP (TP: RM10.85) and UMCCA (TP: RM7.50).

Resilient demand from Indonesia biodiesel industry so far. Our Indonesia biodiesel demand tracker by using MPOB Palm Oil Imports (POI) continued to show sustainable biodiesel usage in Indonesia. In the month of August 2013 when Indonesia announced plans to raise its biodiesel admixture to 10.0% (from 7.5%), POI tumbled 88% YoY to only 7,533 mt (the lowest in almost seven years). This trend of significantly lower POI YoY into Malaysia persisted up to the latest Feb 2014 MPOB data (down 91% YoY to 8,259mt) and we think this will continue throughout 2014. Overall, less POI into Malaysia will limit domestic inventory build-up in and this should support to CPO prices at above RM2600/mt throughout the rest of the year.

Malaysia stocks level to continue declining trend in March. Recall that Malaysia palm oil stocks level declined significantly by 14% MoM to 1.66m mt in Feb 2014 and this is way lower than consensus estimate of 1.80m mt at that time. Going forward, we expect the Mar 2014 stocks level to continue declining, by 2% to 1.62m mt. Note that we have revised upwards our stocks level forecast (against previous estimate of 1.52m mt) due to weaker-than-expected exports so far due to lower-than-expected soybean oil prices(which may have been pressured by the arrival of larger than expected supply from Brazil). Nevertheless, our latest estimate for stocks level is still a decline MoM which is positive for CPO prices.

QE tapering net impact is positive on CPO prices. Recall that the US Federal Reserve has started its QE tapering by trimming its monthly bond purchases by USD10b on 18-Dec-2013 and 29-Jan-2014 to the latest amount of USD65b. Since then, USD has strengthened against MYR. We believe that the weakening MYR against USD should make CPO prices more competitive against soybean oil (which is priced in USD). While we also take note that planters with significant debts in USD may experience higher forex translation loss, we believe that the impact from better CPO prices is much more significant.

Bullish outlook for the upcoming CY1Q14 earnings season. As it is, the average CPO price so far in 1Q14 is RM2681/mt or 15% higher YoY against the 1Q13 level of RM2324/mt. While production may decline around 5% YoY based on MPOB production data, the impact from CPO prices movement is usually much stronger than production volume. Hence, our rough estimate shows that earnings should jump by at least 20% YoY in the upcoming CY1Q14 results season which is expected to be announced in May 2014. Looking ahead, we expect the trend of earnings recovery to last throughout 2014 as we believe CPO prices should improve YoY to RM2800/mt from the low base of RM2400/mt in 2013.

Planters’ valuation is still undemanding as current Fwd. PE for most planters are still trading in the range of Average to +0.5 Standard Deviation (SD) above its historical Fwd. PER. As we expect street consensus to upgrade their earnings forecasts, we believe that planters deserve +1.0SD valuation. Valuation wise, we like TSH as its Fwd. PER of ~14x is lower than its mid-cap average of 17x. For big cap planters. SIME also offers good value as its Fwd. PER of ~15x is lower than its bigcap average of 19x. Overall; our top pick is TSH due to its superior FFB growth, which will provide an additional boost to earnings growth besides CPO prices factor.

Source: Kenanga