We keep our NEUTRAL call on the sector as we maintained our CPO price forecast of RM2,200/MT for FY15 in the absence of fresh factors. Although soybean oil (SBO) prices are in a downtrend, the stabilising SBO-CPO premium should lend support to CPO demand. Meanwhile, biodiesel production initiatives in Indonesia are also unattractive due to low crude oil prices and better demand for other CPO-related products. Hence consumption for biodiesel production may not increase beyond the mandated 1.7m kilolitres (kl) or +0.1m kl (+6% YoY). As this is unlikely to offset declining exports, the resulting higher CPO supply could put pressure on prices. In line with the softer CPO price outlook, we estimate CPO prices from April-Dec 2015 should average lower at RM2,170/MT in keeping with our RM2,200/MT full-year forecast. While upside is capped on expectations of a soft 1QCY15 results season, downside is similarly limited as the lower CPO prices are already priced into planters’ share prices. Thus we maintain our NEUTRAL call on the plantation sector. We upgrade IJMPLNT (TP: RM3.57) and FGV (TP: RM2.21) to MARKET PERFORM as values are emerging after recent selldowns resulted in valuations pegged at very undemanding levels. Other stocks recommendations are maintained. We have an OUTPERFORM call on TAANN (TP: RM4.44) and MARKET PERFORM on SIME (TP: RM9.64), PPB (TP: RM15.42), FGV (TP: RM2.21), IJMPLNT (TP: RM3.57), TSH (TP: RM2.30) and UMCCA (TP: RM6.61). Maintain UNDERPERFORM on IOICORP (TP: RM4.40), KLK (TP: RM20.34), GENP (TP: RM9.57) and CBIP (TP: RM2.05).

Another soft quarter in 4QCY14. Of the eleven stocks under our coverage, five companies (FGV, IOICORP, KLK, SIME and UMCCA) came in below consensus’ expectations largely due to lower CPO prices and seasonal FFB production weakness. Downstream players (particularly IOICORP and KLK) were hit by weak refining margins. On the bright side, PPB’s earnings and dividend beat expectations due to higher earnings contribution from Wilmar, while GENP came in above expectations thanks to a one-off gain from a sizable land disposal. Other planters such as CBIP, IJMPLNT, TAANN and TSH generally met expectations.

Stabilising Soybean oil (SBO) premium should support demand… We observed that the SBO to CPO price premium appears to be stabilising as 1Q15 premium averaged USD71/MT and ranged between USD49-89/MT. In comparison, 1Q14 average was at USD66/MT but the range was wider at USD33-107/MT. Hence the premium trend seems to be becoming more range-bound (see Chart 1 on page 3). We are positive on a stable SBO-CPO premium band as this should reduce the substitution risk of SBO in price-sensitive markets (such as India and Pakistan) and is likely to be supportive to CPO demand. … but soy price downtrend continues. However, SBO price remains on a downtrend, with YTD average price of USD702/MT being 14% lower than the 2014’s average of USD814/MT. We think this trend should continue with USDA forecasting FY15’s SBO supply to rise to 47.4m (+5.5%) on the back of another record global soybean harvest. This could be negative for CPO prices, which have a >90% correlation with SBO prices in the last two years.

Biodiesel production remains unattractive. In the current environment, biodiesel production remains uneconomical as CPO prices of USD615/MT is more expensive than both Brent crude oil (USD418/MT) and gasoil (USD525/MT). We observe that the Indonesian state-owned oil & gas company Pertamina has only been able to secure biodiesel supply through its open tenders when CPO prices were below gasoil price (see Chart 2 on page 3). The current unsubsidised cost of B15-blend biodiesel is estimated at USD526/MT which is close to gasoil price at USD525/MT. Given that this is pre-transportation cost of USD20-30MT and other storage costs, we think unsubsidised biodiesel in the current environment is unattractive for producers. We do note that a biodiesel subsidy of IDR4000/l (USD363/MT) translates to a lower biodiesel price at USD181/MT, well below gasoil prices and sufficient to cover both transportation and storage. Nevertheless, we opine that producers may still prefer to cater to the less complex and greater demand for other CPO-based products such as cooking oil. This might explain why Pertamina did not secure its full biodiesel requirements (required 5.3m kl, actual 4.1m kl) through their tenders. Considering previous efforts, we think that actual biodiesel implementation remains a significant challenge, thus its impact on CPO demand may be limited.

Biodiesel as a “demand catalyst” needs more support. Despite the recent news of B10 to B15 effective 1-Apr-15, we have not seen any confirmation that the IDR6.8t subsidy allocation (translating to 1.7m kl based on IDR4k/l) has been increased accordingly. Thus, we think that production may not exceed the subsidised amount of 1.7m kl since producing unsubsidised biodiesel is still unattractive at the current crude oil price. Note that this is only 0.1m kl (<0.1m MT) higher than 2014 domestic consumption of 1.6m kl. As mentioned above, we are not optimistic that unsubsidised biodiesel consumption will increase markedly in 2015. Therefore, we think any CPO price impact will only be temporary unless the subsidy program is substantially expanded, or mandated enforcement stepped up.

Softening exports to pressure CPO prices. CPO exports continue to weaken as Malaysia exports have declined for three months in a row and Indonesian exports for four months. Notably, exports to China have halved as of Feb-15 in Indonesia (- 45% to 296m MT) and Malaysia (-50% to 281m MT) which we opine is due to the slowing Chinese economy as well as cheaper soybean prices. This could have a significant impact on both Malaysian and Indonesian palm oil exports as China is the largest palm oil importer by volume, making up 17% or 2.8m MT of 2014 exports in Malaysia and 11% or 2.4m MT of 2014 exports in Indonesia. We estimate that a 10% decline in China exports translates to 0.5m MT lower palm oil demand for both Malaysia and Indonesia. Considering that additional biodiesel demand could utilise only <0.1m MT additional CPO, we think that lower exports – and hence higher supply – could place greater downward pressure on CPO prices in the coming year. So how low can CPO prices go? As we are maintaining our FY15E CPO average at RM2,200/MT (and given Jan-Mar average of RM2,265/MT) we estimate that CPO prices in Apr-Dec should average lower at RM2,170/MT. We think this is possible given the scenarios outlined above. Should negative price pressure persist, we may downgrade the sector to UNDERWEIGHT if CPO prices stay below RM2,030/MT for an extended period, i.e. 2-3 months. If this occurs, planters’ earnings would likely miss consensus expectations, which would then lead to lower share prices. Having said that, we think chances of this is limited as base edible oils demand should support prices.

Expect a seasonally soft quarter in 1Q15. We think 1Q15 results reporting season is likely to miss consensus as our forecasted 1Q15 production of 3.54m MT only makes up 18% of our full-year estimate of 19.80m MT. YoY performance should be weaker as 1Q15 CPO price of RM2,265/MT is 16% lower (1Q14: RM2,693/MT) while CPO production in 1Q15 is expected to be 17% lower (1Q14: 4.28m MT). QoQ performance could be weaker too, because although 1Q15 CPO price is 3% higher (4Q14: RM2,194/MT), CPO production is significantly lower by 29% (4Q14: 5.00m MT). In our view, the lower earnings outlook should keep upside limited for planters in the short-term. We think the greatest earnings risk lies in pure planters as they have the greatest exposure to CPO prices and productivity fluctuations. Under our coverage, we think pure planters with high forecasted FFB growth, i.e. GENP (UP; TP: RM9.57), IJMPLNT (MP; TP: RM3.57), TSH (MP, TP: RM2.30) and UMCCA (MP; TP: RM6.61) could see seasonal earnings weakness. However, share price downsides are limited despite weaker CPO price outlook. Although we expect CPO prices to trade around the RM2,200/MT level in the near term, we think that planter’s share prices should stay relatively resilient. This is based on the historical pattern seen in the last CPO price downtrend cycle (Mar-14 to Sep-14) when CPO prices declined 33% from its peak at RM2,895/MT but the KLPLN Index decreased by only 16% from peak to trough (see Chart 3 on page 4). We found that planters' share prices tend to be more stable than CPO prices in a downturn which we think is due to: (i) their big-cap planters’ weighting of 14% in the FBMKLCI, (ii) high institutionalized holdings by long-term funds, (iii) the scarcity of Shariah-compliant counters in the market. Furthermore, we also observe that the KLPLN’s 2-year total return of - 4.8% versus the KLCI (+7.7%) represents a 12.5% discount or -2.5SD to the historical premium/discount (see Chart 4 on page 4). We believe this signals that downside to planters’ share prices should be limited as the weaker CPO prices have already been priced in.

Earnings maintained; IJMPLNT & FGV upgraded to MARKET PERFORM. We maintain most of our recommendations and estimates because we have already built in most of the aforesaid weaknesses during the last two quarters. Hence, we remain comfortable with our valuation basis mostly between -0.5 to +0.5SD on historical PER. However, we have decided to upgrade IJMPLNT (TP: RM3.57) and FGV (TP: RM2.21) to MARKET PERFORM as values are emerging after the recent sell-downs (refer to Appendix for details) and we have pegged valuations at undemanding levels of +0.5SD and -2.0SD respectively.

Maintain NEUTRAL on plantation sector. We are overall neutral on the plantation sector as we expect CPO prices to trade between RM2,100/MT-RM2,300/MT, in line with our FY15 forecast of RM2,200/MT. Although we forecast CPO prices to be 8% lower against FY14, we think downside is limited by planters’ depressed valuations as well as the heavy weightage of planters on the FBMKLCI and scarcity of Syariah-compliant stocks. Potential catalysts would be fresh commitment from the Indonesian government on biodiesel usage, including distribution infrastructure, which should improve sentiment for CPO prices. However, declining SBO prices and weakening export trends would be limiting factors for CPO price upside. 

Source: Kenanga Research - 6 Apr 2015