We maintain our NEUTRAL call on Plantation as we expect near-term excess supply to limit upside despite better demand. Our study on recent headliner El Nino indicates the certainty and quantum of CPO price rallies have been on the decline, likely due to the emergence of other price factors. Instead, we think that the ample near-term edible oils supply should be offset by higher CPO demand due to a wider soybean oil (SBO)-CPO premium and weak Ringgit. The upcoming Indonesian palm oil levy could help Malaysian CPO exports, but we expect slow-paced implementation of the biodiesel program given cheap crude oil and the lack of infrastructure. Despite few near-term catalysts, the downside is limited as we expect upcoming 2Q15 results to come in within expectations, and note that most planters are now trading below their historical mean levels. No change to FY15E CPO forecast of RM2,200/MT as we introduce our higher FY16E CPO price of RM2,400/MT, which reflects our expectations of better demand, higher crude oil prices, and a weak ringgit. We raise earnings forecasts and TPs across the board as we revise higher our CPO forecast. Upgrade IOICORP (TP: RM4.50) to OUTPERFORM and upgrade KLK (TP: RM21.80), FGV (TP: RM1.75) and GENP (TP: RM10.42) to MARKET PERFORM on emerging value as all are trading below -0.5SD valuation. Our Preferred Picks are TAANN (TP: RM4.80) for its undemanding valuation and above-average FFB growth and CBIP (TP: RM2.49) for its less volatile orderbook-based earnings and strong balance sheet. Maintain MARKET PERFORM on SIME (TP: RM9.04), PPB (TP: RM16.50), IJMPLNT (TP: RM3.73), TSH (TP: RM2.45) and UMCCA (TP: RM6.70).

1QCY15 results weak as expected. Of the 11 stocks under our coverage, only one (IJMPLNT) came in above consensus expectations while 5 were within. 5 stocks came in below market expectations, namely FGV, GENP, KLK, SIME and UMCCA. This is slightly weaker than the previous quarter in which 2 stocks were above, 4 within, and 5 were below. Planters suffered adverse weather conditions resulting in poor production, which declined 7-38% QoQ and 0-30% YoY, where mid-size planters were worst hit (>20% declines). Downstream players including SIME, IOICORP, KLK and FGV were also hit by softer margins in the oleochemicals and refining businesses. 5 of the 11 stocks saw earnings forecasts cut by 4-30% with the greatest revision for SIME (FY15-16E -30% and -21%) due to poor Industrial, Plantation and Motor division outlooks.

El Nino – not a conclusive price factor. Based on our study of previous El Nino events; historically, dry weather conditions do have a positive CPO price impact. However, we notice that recent events have a lower degree of certainty, and the quantum of CPO price change is now on a declining trend. Also, the length and severity of El Nino does not seem to affect the quantum of CPO price change (refer to Tables 1-3 for impact study of dry periods against CPO prices, KLPLN Index and CPO production). We think this is because many other factors have emerged over the last decade that also have a strong sway on CPO prices, such as soybean oil (SBO) prices and biodiesel demand. We believe the “El Nino” factor is largely a sentiment play on CPO prices and that price rallies require demand rather than supply factors to boost this.

Plentiful supply of edible oils. Near-term edible oils supply, led by CPO and SBO, are at all-time highs, with a recent Oilworld report mentioning that “world stocks of soybeans will still be at record high as of end-August-2015”. Furthermore, CPO production is entering into its peak period even as Malaysia’s April and May 2015 hit monthly production records. We expect rising production in the next 3 months which is likely to cap near-term CPO price upside.

Focus on demand to support CPO prices in 2H15. We think 2H15 CPO demand is likely to strengthen, in line with historical patterns of stronger Indian and European demand in 2H. This is supported by the wider SBO-CPO premium (2Q15 quarter-to-date (QTD): USD115/MT vs. 1Q15: USD74/MT and 1Q14: USD66/MT; see Chart 1) and a weak ringgit. Furthermore, given that 5M15 exports at 6.14m MT is 8% lower than 5M14 at 6.65m MT, there is a good chance we will see demand playing catch-up in the latter half of the year. Hence, we expect 2H15 CPO exports at 9.96m MT, or 28% above our 1H15 CPO export forecast of 7.78m MT, and this should help offset the negative price pressure from seasonally higher 2H production.

Indonesian levy could boost Malaysian CPO exports. As highlighted in our Plantation Sector Update (published 28-Apr), we expect the upcoming USD50/MT CPO export levy to reduce the share of CPO exports from Indonesia. This translates to approximately 8% of taxes on Indonesian CPO (assuming CPO price at USD600/MT) compared to 0% in Malaysia currently. We have observed that the Malaysian CPO export share is greater when the export tax rate in Malaysia is lower than Indonesia (see Chart 2). Hence, assuming total Malaysian and Indonesian exports to average 3.20m MT/month and 45% export share for Malaysia, we expect 2H15 monthly exports to comfortably average above 1.40m MT/month (against 5M15’s average of 1.23m MT/month).

Biodiesel is a plus, but it won’t be speedy. However, despite the Indonesian levy being announced late-April, the multiple delays so far dim our confidence in speedy implementation and/or enforcement of the biodiesel initiatives the levy is meant to fund. With consistently low oil prices so far, we are inclined to think that biodiesel program could remain low priority for now. Nevertheless, once the program is implemented, CPO prices should see a boost due to higher demand uptake. Still, investors should keep in mind that there is still a long way to go, as Indonesian infrastructure and enforcement still need more work before we see convincing results from the biodiesel program.

2Q15 likely to be within expectations. We believe 2Q15 results will come within expectations as our expected Malaysia 2Q15 production at 5.22m MT makes up 26% of our full year-estimate of 19.80m MT while 2Q15 QTD CPO prices average RM2,191/MT, very close to our full-year forecast of RM2,200/MT. QoQ, 2Q15 results are likely to improve as Malaysian production jumped 38% despite QTD CPO prices slipping 3%. However, YoY results could be slightly weaker as CPO prices fell 15% against 2Q14, though this could be partly offset by 9% higher production. We favour pure planters with high forecasted FFB growth such as TSH (MP, TP: RM2.45), IJMPLNT (MP, TP: RM3.73) and GENP (MP, TP: RM10.42) to counteract the CPO price weakness.

Expecting range-bound CPO prices in 3Q15. We think CPO prices are likely to continue trading range-bound heading into 2H15 as year-to-date (YTD) CPO prices at RM2,230/MT have so far traded close to our full-year forecast. Although we anticipate demand outlook to improve, supply is also expected to rise at least up to Sep-15. Hence, we think near-term CPO outlook to trade range-bound between RM2,000-RM2,400/MT, although with a possibility of trading higher on positive sentiment if dry weather strongly intensifies.

However, share price downsides are limited. Although we expect CPO prices to trade around the RM2,200/MT level in the near term, we think that planter’s share price should stay relatively resilient. This is based on the patterns seen in the last CPO Price downtrend cycle (Mar-14 to Sep-14) when CPO prices declined 33% from its peak at RM2895/MT but the KLPLN Index decreased by 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-funds, and (iii) the scarcity of Shariah-compliant counters in the market. Furthermore, we also observe that the KLPLN’s 2-year total return of -11% versus the KLCI (+2%) represents a 13% discount or -1.8SD to the historical premium/discount (see Chart 4 on page 6). We believe this signals that downside to planters’ share price should be limited as the CPO price decline has already been priced in Most planters trading below historical mean. After a round of mostly weak 1Q15 results and stubbornly low CPO prices, we note that most planters are trading at depressed valuations (below historical mean PER). Of the 11 stocks under our coverage, 4 counters are trading between -0.5SD to mean valuation namely SIME (MP, TP: RM9.04), PPB (MP, TP: RM16.50), GENP (MP, TP: RM10.42) and CBIP (OP, TP: RM2.49). Meanwhile, KLK (MP, TP: RM21.80) is trading between - 1.0SD and -0.5SD. The remaining six counters are trading below -1.0SD valuation: IOICORP (OP, TP: RM4.50), TAANN (OP, TP: RM4.80), FGV (MP, TP: RM1.75), IJMPLNT (MP, TP: RM3.73), TSH (MP, TP: RM2.45), and UMCCA (MP, TP: RM6.70). Given our near-term expectation of range-bound low CPO prices, we think valuation between -1.0SD to mean valuation is justified. However, long-term investors could seek value in deeply discounted stocks such as IOICORP (-2.7SD), UMCCA (-1.7SD) and IJMPLNT (-1.6SD).

Signs point to better FY16 CPO Prices. We introduce our FY16 CPO price of RM2,400/MT based on the assumptions of: (i) average SBO price of 32 US cents/pound, (ii) USD Index estimate of 97.0, (iii) Malaysia palm oil inventory of 1.56m MT, and (iv) average Brent crude oil price of USD71.0/barrel. Note that we have re-based our model to Jan-07 (from Jun-05) to reduce the currency volatility impact of the ringgit unpegging against the USD in mid-2005. We expect the flat USD expectation (FY15E USDMYR: 3.73; FY16E USDMYR: 3.72) to maintain CPO’s export attractiveness. Our FY16E CPO price of RM2,400/MT is 9% higher against FY15E, reflecting our expectation of improving demand fundamentals. 

Source: Kenanga Research - 3 Jul 2015