We maintain our NEUTRAL call for the plantation sector as our short-term bullish view on CPO prices is very much neutralised by the lacklustre outlook for the upcoming 3QCY14 results season in Nov-2014. In the near-term, we expect CPO prices to recover to an average of RM2500/MT in 4QCY14 which should bring full-year CY14 average to also RM2500/MT premised on our view that: (i) soybean oil prices have bottomed (due to increasing production risk) and (ii) palm oil inventory have peaked in Aug (as peak production season has arrived earlier). Despite the optimism seen for CPO prices, the upside is limited for planters as the upcoming 3QCY14 results season is likely to see YoY decline. Lastly, most planters have only managed to meet consensus earnings expectations for 2QCY14. Our only top pick is SIME (OP; TP: RM10.10) due to potential spin-off exercise within SIME business divisions. Maintain MARKET PERFORM on IOICORP (TP: RM5.30), KLK (TP: RM23.80), FGV (TP: RM4.00), PPB (TP: RM15.00), TSH (RM3.40), TAANN (TP: RM4.55), UMCCA (TP: RM7.15) and CBIP (RM4.85). Maintain UNDERPERFORM on GENP (TP: RM9.55) and IJMPLNT (TP: RM3.50).

2QCY14 results mostly within expectation with nine in line and two below. IOICORP’s earnings were below consensus estimate as its downstream division’s margin came in lowerthan-expected as it declined in 4Q14 to only 3.8% (against 4Q13’s 4.7% and 3Q14’s 7.3%) possibly due to high material cost. Another disappointing set of results were from FGV due to lower-than-expected 1H14 FFB growth (-3% YoY to 2.37m MT). Companies that met expectations are SIME, KLK, PPB, GENP, IJMP, TSH, TAANN, UMCCA and CBIP.

Soybean oil prices should have bottomed. While the United States’ soybean production is still exceptionally good, we gather that there is risk to the production due to frost or light freeze in the Northern US. Hence, we believe that USDA is likely to stop increasing its soybean production numbers in the next release and stop the pressure on soybean oil prices. Additionally, South America’s production risk is also increasing as Oil World reported that Argentina experienced severe flooding in the Buenos Aires province with some area receiving more than double the usual rainfall. Overall, this is positive to CPO prices as it is strongly correlated to soybean oil (SBO) prices as both are common substitute for the food industry.

Reducing our inventory estimate by 8% to 2.03m MT. We have reduced our palm oil stocks level estimate for Malaysia due to weaker-than-expected production in Sep. Note that our channel checks reveal that Sep production actually declined MoM (against past seasonal trend and our earlier estimate of 5% increase MoM). As a result, we have now assumed an 8% MoM decline in Sep production to 1.87m MT. In our view, the production peak month has arrived earlier this year in August and we are likely to see lower production in 4QCY14. On the demand side, we expect good demand growth of 16% MoM to 1.67m MT. Overall, lower inventory should be positive to CPO prices as it reflects higher demand against supply.

But short-term earnings prospect in 3Q14 is not good. The upcoming 3QCY14 result season in end-Nov is likely to show a decline in earnings YoY due to lower CPO prices. Note that quarter-to-date (QTD) CPO price of RM2222/MT is lower by 5% against 3Q13’s RM2344/MT. On a QoQ basis, we think earnings are likely to be flattish despite seasonal CPO production increase of between 16% to 18% which would likely be neutralised by lower CPO prices, by 13% QoQ to RM2237/MT (against 2Q14’s RM2576/MT). In our view, lower earnings outlook should keep the upside limited for planters’ share prices. Having said that, the downside is also limited due to ample liquidity seen in the local market and overall flattish share price performance YTD.

Expect CPO prices to recover to average RM2500/MT in 4QCY14. We maintain our estimate of RM2500/MT for CY2014 as we expect similar average CPO prices of RM2500/MT in 4QCY14 with YTD Average at RM2510/MT. We expect CPO prices to recover to RM2500/MT as we expect better demand from India due to the upcoming Deepavali celebrations on 22-Oct-2014. Additionally, production should decline earlier this year in October. As a result, demand is likely to exceed supply and push CPO prices higher to RM2500/MT in 4Q14. While we are bullish on CPO prices, we believe that planters’ share prices are unlikely to appreciate significantly as KL Plantation Index only declined around 10% to 8421 points against CPO prices decline of 25% from the peak.

Maintain NEUTRAL with SIME as our only top pick. We like SIME as we think its valuation should rerate higher due to potential spin-off exercise within SIME’s business divisions. As it is, it has been reported by the media quoting Tan Sri Mohd Bakke Salleh (SIME’s CEO) specifying that the listing of its motor unit is set to be executed in 1HCY15 subject to market conditions. The stock is also cum-dividend of 30.0 sen (subject to approval in the AGM).

Source: Kenanga