Reuters reported that Malaysia will keep tax on CPO exports at 0% for Mar-15. This came as a surprise, considering recent media reports which suggested otherwise, as we had expected an export duty of 4.5% to be imposed in line with the RM2,251-RM2,500 CPO price tier. However, we are neutral either way as we think maintaining zero duty is unlikely to affect CPO exports which have been duty-free since Sep-14. Meanwhile, imposing the duty would have limited effect (see Kenanga Today: 13-Feb-15). On a broader scale, maintaining zero duty should preserve Malaysian CPO price competitiveness against Indonesian CPO. While sector impact is neutral, we think downstream players will feel more heat as they are already impacted by overcapacity in the industry. This includes SIME (OP; TP: RM9.92), PPB (MP; TP: RM15.26), FGV (MP; TP: RM2.30), KLK (UP; TP: RM20.34) and IOICORP (UP; TP: RM4.40) with the heaviest downstream exposure in IOICORP (24% EBIT) and KLK (20% EBIT). We remain NEUTRAL on the sector and maintain our FY15E CPO price forecast at RM2,200/MT. We think prices will trend lower in 2H15 due to high production, weak Ringgit and low crude oil prices. However, share prices should be supported due to the high number of big-cap planters and Shariahcompliant stocks. Our Top Pick for the sector is SIME on its motor division IPO catalyst. We also maintain MARKET PERFORM on IJMP (TP: RM3.30), TSH (TP: RM2.18), TAANN (TP: RM3.70), UMCCA (TP: RM6.68), and CBIP (TP: RM2.05); and maintain UNDERPERFORM on GENP (TP: RM9.20).

Maintaining status quo on export duty. Reuters reported on 16-Feb-15 that “Malaysia has kept tax on exports of crude palm oil at zero for March… extending a duty-free policy held since October. The move, which is likely to underpin prices, comes as a surprise as Malaysia's plantation industries and commodities minister said last week the country was planning to resume taxing exports from March. The rate was scrapped from October to December, and later extended to end-February. Malaysia, the world's second largest palm oil producer after Indonesia, calculated a reference price of RM2,233/metric ton (MT) for March crude palm oil, effectively incurring an export duty of zero percent.”

Neutral on news. The news of extended zero export duty in March is a surprise to us as we had previously pointed out in a comment that a CPO price range between RM2,251-RM2,400 should lead to an export duty of 4.5% based on the tiered CPO tax structure. Either way we are neutral. We think that maintaining the status quo is unlikely to result in significant improvement to domestic CPO exports which have been duty-free since Sep-14. Neither would there be much impact if they had imposed the 4.5% export duty (refer to Kenanga Today: 13-Feb-15). Note that cargo surveyor Intertek has reported that Malaysia CPO exports from 1-Feb to 10-Feb has declined 16% to 298.9k metric tons (MT), while our Feb-15 export forecast is minus 8% to 1.09m MT. However, on a broader scale, maintaining a zero duty tax structure will maintain the competitiveness of Malaysian CPO compared to Indonesian CPO. This is because the Indonesian CPO tax structure is similar to Malaysia, whereby a CPO price range of USD751-USD800 should lead to 7.5% export duty imposed. However, Feb-15 month-to-date (MTD), CPO price CIF Rotterdam is USD683/MT, unchanged from Jan-15 and 9% below the USD751 CPO price floor for export duties. Thus we think Indonesia is unlikely to impose export duty in the nearterm as well. Although we think that the news is unlikely to affect CPO prices as we expect export downtrend to persist, downside is limited as the move is likely to keep Malaysian CPO prices competitive against Indonesia.

Biggest losers in the downstream side. While the impact is neutral on the overall sector, we think downstream players will feel more heat from the move to maintain zero duty. As it is, there is overcapacity which is eating into margins. This includes SIME (OP; TP: RM9.92), PPB (MP; TP: RM15.26), FGV (MP; TP: RM2.30), KLK (UP; TP: RM20.34), and IOICORP (UP; TP: RM4.40). Note that the planters with the largest downstream exposure earnings-wise would be IOICORP and KLK at 24% and 20% of operating profit, respectively. With the diminished downstream outlook and KLK missed quarterly earnings expectations, we have downgraded our call and TP on KLK. For details please refer to KLK’s Results Note update released concurrently today (16-Feb-15). The extension of zero duty to March means that downstream margins in 1QCY15 will remain compressed, as export duties allow refiners to have some degree of bargaining power on their local CPO feedstock. Hence we rate IOICORP and KLK as UNDERPERFORM as we think their earnings may miss expectations again in the coming May reporting season, especially when taking into consideration the excess downstream capacity in Malaysia and Indonesia which is likely to persist for the next 6-12 months.

Maintain NEUTRAL on sector with unchanged CPO price of RM2,200/MT. Although the news of unchanged export duty is unlikely to result in a significant boost to exports, we think downside is limited as the move should help preserve the competitiveness of Malaysian CPO. We also maintain our FY15E CPO price forecast of RM2,200/MT because we think CPO prices are likely to trend lower in 2H15 as peak production kicks in, compounded by a softer Ringgit and lower crude oil prices. However, share prices should be supported due to the high number of big-cap planters and Shariah-compliant stocks. Our Top Pick for the sector is SIME (OP; TP: RM9.92) as we anticipate excitement over its motor division IPO to surpass expected softer performance in its plantations division. 

Source: Kenanga