For our 4Q15 sector outlook, we reiterate our NEUTRAL call on plantations with no change to our FY15-16E CPO price forecasts of RM2,200-RM2,400/MT. Despite a brightening long-term outlook, we expect few short-term catalysts to extend the recent price rally. However, we think the ongoing dry weather to result in soft FY16E production growth of between -2% to +1%, depending on El Nino intensity. For FY16E, demand from India and China is expected to be higher than FY15E due to local production shortfalls. However, short-term CPO prices will be range-bound between gasoil prices and soybean oil prices with an expected trading range of RM2,100-RM2,450/MT. The Indonesian biodiesel outlook remains challenging despite levy collections coming in line, as fully supporting subsidies may require tradeoffs between replanting plans. We expect any possible tax reductions in the upcoming Budget 2016 to result in <3% incremental earnings. Planters’ upside is limited by an expected lacklustre 3Q15 and potential production hit from current climate dryness. However, downside is limited as several planters have likely bottomed out during the August correction, with only moderate nearterm upside expected for the KLPLN Index after the recent rally due to persistently high expected inventory. We downgrade FGV (TP: RM1.30) and GENP (TP: RM9.50) to UNDERPERFORM post rally. Our TOP PICK is TAANN (OP; TP: RM4.80) on undemanding valuations (FY16E PER: 10.8x) and potential timber earnings upside. Other calls and recommendations maintained, i.e. OUTPERFORM on TAANN (TP: RM4.80), CBIP (TP: RM2.13), MARKET PERFORM on SIME (TP: RM8.30), IOICORP (TP: RM4.36), KLK (TP: RM21.80), PPB (TP: RM16.92), IJMPLNT (TP: RM3.50), TSH (TP: RM1.95), and UMCCA (TP: RM6.30).

2QCY15 weak as expected. Of the 11 stocks under our coverage, 2 stocks (IOICORP and TAANN) come in above consensus expectations, while 4 were within. 5 stocks performed below market expectations: FGV, IJMPLNT, KLK, TSH and UMCCA. This matched the previous soft quarter where 2 stocks were above, 4 within, and 5 below. Several planters were hit this quarter by dry weather in parts of Sabah and Kalimantan. This resulted in an average YoY FFB production increase of only 2%. Average CPO price received fell 13%, resulting in average YoY CNP decline of 27%. In fact, 9 of 11 stocks saw CNP decline YoY. As a result, 6 stocks saw FY15-16E earnings downgrades (from -5% to -24%) while none saw earnings upgrades. The biggest cut was applied to FGV (-23% and -34%) on weak FFB growth outlook and high operating costs.

Potential downside to FY16E production. MPOB recently announced a RM100m replanting program for 83k ha, expected to take place from Oct-15 to Dec-15. The program subsidizes replanting cost by RM1,000-1,500 per hectare (ha). We expect the program to benefit planters with a higher proportion of older trees such as FGV (average age: 18 yrs), IOICORP (avg age: 14 yrs) and SIME (avg. age: 13 yrs), although earnings impact should be minimal for these companies. The program is estimated to reduce CPO production by 250k MT or 1.3% of FY15E production. Although the production impact is relatively small, this combined with tree stress from ongoing droughts may result in flat or negative production growth in FY16E. While we acknowledge that El Nino’s historical impact on production has been mixed, we think that in the light of severe droughts in parts of East Malaysia since early 2015, and projections of El Nino lasting up to early 2016, there is increasingly risk of tree stress impacting production from end-2015 onwards.

FY16E production growth to range from -2% to +1%. To assess the potential impact of tree stress, we performed a scenario analysis with a base case of 1% YoY production growth to 20.0m MT (after including the replanting program). In the Slight Stress scenario, (-1.2% production impact, the lowest negative production impact historically seen from El Nino) could result in flat YoY production at 19.8m MT. In the Medium Stress scenario, (-3.0% production impact, at average negative production) could result in -2% YoY production to 19.4m MT. In the High Stress scenario, (-4.7% production impact, the highest negative production) could result in -4% YoY production to 19.1m MT. However, keep in mind that the High Stress scenario is less likely to occur as rainfall in Peninsular Malaysia has not declined as dramatically as in East Malaysia. Hence, the likeliest FY16E production growth range is from -2% to +1%, depending on intensity of the drought. Nevertheless, we will refrain from incorporating the tree stress impact into our CPO forecast due to the substantial weather uncertainty; we believe the situation should become clearer towards year-end. 

Source: Kenanga Research - 7 Oct 2015