We recently met with IOI Corporation (IOICORP) management - Mr Kevin Wong (Chief Financial Officer) and Mr Lawrence Leong (Investment Manager) and came away neutral on IOICORP’s short-term prospects, although the long-term outlook remains bright. Regarding its possible suspension by RSPO, actual financial impact would be minimal (<5% of FY16E CNP), but the reputation impact is unquantifiable. Meanwhile, although its FFB production is seen weaker in FY16, we expect recovery in FY17E. Production costs should be stable, while downstream performance should improve in 2H16 on the return of CPO export duties. We maintain our MARKET PERFORM call with a lower TP of RM4.88 on unchanged Fwd. PER of 24.1x applied to slightly lower CY16E EPS of 20.3 sen (previously 20.6 sen).

Potential RSPO suspension? We discussed the recent newsflow on a suspension recommendation by the RSPO Complaints Panel due to land clearing issues, which occurred in 2009. Management noted that the land issue had been previously closed by the RSPO in mid-2012, and mentioned that the area had since been rehabilitated. Nevertheless, we understand that IOICORP has submitted the requested action plan, which they hope will be accepted before the deadline for the suspension decision. In our view, we estimate minimal financial impact to the group, as we gather that there are alternative buyers who do not place a premium on RSPO-certified palm oil. Assuming one month of suspension and the consequent loss of business from Europe and America-based MNCs, we expect to see <RM50m or <5% impact to FY16E earnings. However, the potential reputation damage may have an unquantifiable impact to IOICORP’s client base, as Europe and America made up c.51% of FY15 revenue.

FFB production to recover in FY17E. We gather that the recent drought has adversely affected IOICORP’s plantation, particularly in Sabah. Management mentioned that they expect FY16E FFB production to decline by 1-3%, although OER has been stable-toslightly better at about 22.0%. As they expect production to normalise in mid-2016, FY17E earnings are likely to be boosted from a lower base and new contribution from maturing Indonesian landbank to see FFB growth of 6-8%. In line with management’s guidance, we have lowered our FY16-17E FFB growth forecast from +4% and 0% to - 2% and +7%, respectively. We note that the FY16E production decline is generally in line with other big cap planters, while FY17E growth potential at 7% is closer to sector average (+6%).

Expecting stable production cost. Management expects to maintain its gross production costs at c.RM1,300/metric ton (MT) in Malaysia and c.RM1,550/MT in Indonesia. They expect the coming minimum wage policy and foreign worker levy hike (+8% to RM640/worker) to result in Malaysian labour cost increase by c.3%. However, this is offset by lower fertiliser cost of c.3% due to a stronger ringgit as well as low crude oil prices.

Downstream operations gradually improving. 2H16 downstream operations should begin seeing improvement, as the recent return of CPO export duties (5.0% in Apr-16) should increase refining margins. We understand that IOICORP’s specialty fats business continues to see good margins due to their high-end product mix. Meanwhile, refining margins tend to be stronger in an appreciating CPO price environment as end-product prices tend to be higher than feedstock prices after the processing period. Hence, we expect to see stronger 2H16 performance in the downstream segment, especially as a stabilising ringgit should result in lower foreign exchange and derivatives losses.

Maintain MARKET PERFORM with lower TP of RM4.88. We maintain our neutral view on IOICORP but lower our TP to RM4.88 (from RM4.96) as we adjust our FY16-17E earnings forecast by -5% and +2% to RM1.23-RM1.36b, respectively, after accounting for the changes in our FFB growth assumptions. We apply an unchanged Fwd. PER of 24.1x which is based on mean valuation, reflecting the overall neutral FFB growth prospects as well as positive downstream outlook, which could be tempered by reputation risk arising from a potential RSPO certificate suspension.

Source: Kenanga Research - 24 Mar 2016