We recently met with IOI Corporation (IOICORP)’s Chief Financial Officer - Mr. Kevin Wong, and Investment Manager - Mr. Lawrence Leong. We maintain our NEUTRAL view on IOICORP with a soft near-term outlook given modest YTD production improvement but better 2H17 prospect as downstream businesses should see some client recovery in 2H17. FY17-18E earnings cut by 11-3% after imputing lower processed palm oil premiums post-RSPO suspension. Reiterate MARKET PERFORM with lower TP of RM4.60 (from RM4.67) post-earnings downgrade.

Gradual improvements post-suspension. We gather that since the RSPO suspension was lifted, the upstream business is again able to sell Certified Sustainable Palm Oil (CSPO) which fetches a premium of c.USD30/MT above CPO prices. On the downstream side, while we understand that some buyers have resumed purchases post-suspension, some big-name MNCs have yet to resume buying as many contracts have been locked in for the year. Given the company’s efforts to improve its sustainability policies and comply with RSPO principles, we think IOICORP should be able to partially recover some major clients by 2H17. However, we think that the slow business recovery and on-going negotiations could result in less favourable specialty fats margins compared to presuspension.

Partial production recovery seen in FY17E. In line with other planters, IOICORP’s FFB production declined 11% in FY16 due to the lagged impact from droughts seen in CY14/15. Looking ahead, management does not expect complete recovery in FY17 but thinks that 5-6% production growth is realistic. This is in line with our FY17-18E FFB growth forecasts of 6-7%. We understand that year-on-year growth is only likely from 2H17 onwards, with weaker growth expected in 1H17 due to continued El Nino impact.

Moderate cost pressures from labour. Management noted that FY16 CPO cost/metric ton (MT) was c.15% higher at RM1,400/MT mainly due to lower yields and higher labour costs. With recent minimum wage hikes, management expects total cost to increase c.5%, although this should be offset by higher productivity and stable fertiliser cost.

Considering acquisitions? We gather that IOICORP has c.8-9k hectares (ha) of plantable area remaining after excluding HCV/HCS area. We expect this area to be fully planted within the next two years. With plantable reserves running low, we expect IOICORP to be on the lookout for land acquisitions, likely with a preference for brownfield (planted) area.

FY17-18E CNP reduced 11-3% to RM1.05-1.30b. We reduce our FY17- 18E CNP by 11-3% to RM1.05-1.30b as we trim our processed palm oil premium assumptions to reflect lower average premiums post-suspension.

Maintain MARKET PERFORM with lower TP of RM4.60 (from RM4.67). Our TP of RM4.60 is based on lower CY17E EPS of 16.4 sen (previously 19.7 sen) applied to an updated Fwd. PER of 25.0x (previously 23.7x). This implies an unchanged -0.5SD valuation basis. We are comfortable with our valuation basis given slower downstream recovery and moderate shortterm FFB growth. Continued scrutiny on its sustainability issues could remain a headwind going into the mid-term.

Source: Kenanga Research - 13 Sep 2016