For 2Q17 we maintain our NEUTRAL outlook on the Plantation sector, believing that CPO price upside is limited by a strong palm and soy production outlook; although downside is contained by range-bound crude oil prices and a strong USD/MYR. Our FY17E CPO price is maintained at RM2,550/metric ton (MT) while 2Q17E CPO price range is unchanged at RM2,700-,2900/MT. We think CPO prices are fairly valued, when looking at stock movements. A rising producton outlook is a given, but price movement will be strongly dependent on strength of exports. Nevertheless, prices have likely peaked for the year, unless new catalysts emerge. Potential catalysts include El Nino emerging, positive biodiesel policy adjustments, and availability risk for US soy. A range-bound crude oil and strong USD/MYR should continue to support prices. With strong 1Q17 CPO prices and better YoY production, we expect a stronger 1Q17 YoY, while QoQ change should be relatively flat. Full-year earnings should see recovery against 2016, but we believe this has been priced in. Hence, planters’ share price are likely rangebound, with potential catalysts to benefit selective stocks (biodiesel: Wilmar & PPB, China demand pickup: large caps such as SIME, IOICORP and KLK). We maintain FGV at MARKET PERFORM with a higher TP of RM2.10 (from RM1.85), accounting for potential synergies from foreign JV. Other calls & TPs are maintained, namely: OUTPERFORM on on IOICORP (TP: RM5.15), IJMPLNT (TP: RM3.92), HSPLANT (TP: RM3.00) and UMCCA (TP: RM7.50); and MARKET PERFORM on SIME (TP: RM9.50), KLK (TP: RM26.00), PPB (TP: RM17.60), GENP (TP: RM12.40), TSH (TP: RM2.00), TAANN (TP: RM4.10) and CBIP (TP: RM2.15).

4Q16 earnings improved. 4QCY16 improved QoQ, as two stocks beat consensus (GENP, HSPLANT), while 6 were within/broadly within and 4 below expectations (FGV, SIME, TAANN, TSH). This is an improvement on 3QCY16 with none above, 8 within and 3 below expectations. With 3Q16 production distorted by lagged drought impact, 4Q16 FFB production improved 10%, while YoY average production declined 10%, slightly outperforming the Malaysian average of -13%. We observe that all planters except TAANN, which saw less drought effect thanks to its Sarawak concentration, saw production declines. Price-wise, fullyear prices rose 23%, at a YoY-YTD ASP of RM2,609/metric ton (MT) with all planters seeing an increase.

CPO price appears fairly valued vis-à-vis stock levels. After the prolonged production impact from 2015, CPO stocks fell in 2016 which corresponded to a jump in CPO prices, especially towards 4Q16. With prices and stock levels pegged to end-2015 base level, we observed that CPO price movement from Jan-2016 onwards had a reasonable correlation of 67% against MPOB stock movements. Referring to the chart on the lower right, we find that compared to stock levels, the CPO price correction in late Feb-17 appears to have taken prices to a more sustainable valuation, vis-à-vis stocks. Note that Mar-17 closing stock levels are based on our own estimates. We think that given current low stocks, CPO prices should remain fairly sensitive to stock movements until stocks recover to more normal levels towards year-end, which will be discussed later.

Rising production outlook. We concur with consensus’ expectations of post-drought production recovery in 2H17. However, with early-2016 dryness slightly impacting production in 1Q17, we expect full-year production to fall short of the previous all-time high in 2015 of 19.96m MT. Hence, we expect actual production to come in closer to our medium-high scenario forecast. Our three projections are presented overleaf, based on 5-year average production, 5-year high, and the medium-high scenario based on the mid-point of average and high exports.

Exports to track production uptrend… Looking at historical trends, it is no surprise that exports tend to correlate strongly with production (>75% correlation). With the strong likelihood of production recovery, we expect exports to trend higher, up to OctNov 2017, although history shows that exports generally average c.90% of production levels. For our scenario-based stock simulation, we project three export scenarios based on the 9-year average, 9-year high, and the medium-high mid-point scenario.

… but demand risk remains. With the ample soy production outlook, we think that palm export recovery may be challenging, despite low global stocks. Oil World recently updated its South American soybean production assumption to 180m MT (+2% from its previous estimate; +9% year-on-year (YoY)), while USA soybean production is estimated at 117m MT (+10% YoY), marking another record high for both regions. Furthermore, palm oil production is expected to recover with estimated global production growth of 10%. With Oil World pegging edible oils consumption growth at only 3%, we think that soybean oil (SBO) and CPO price competition will remain stiff in the near-to-mid-term, particularly for export markets such as Europe and China. This has played out recently in Europe, where CPO prices (CIF Rotterdam) have been trading near SBO prices since mid-2016, corresponding to a declining EU export trend over the same period.

Stocks likely to trend up from 2H17. We put together the above potential production and export projections to come up with six possible stock scenario projected up to end-2017, assuming 3-year average imports and domestic disappearances are fixed. Our stock scenarios are as follows:

• Scenario 1 (S1) - High Production & High Export

• Scenario 2 (S2) - Medium-high Production & Medium-High Export

• Scenario 3 (S3) - Average Production & Average Export

• Scenario 4 (S4) - High Production & Medium-high Export

• Scenario 5 (S5) - Medium-high Production & High Export

• Scenario 6 (S6) - Medium-high Production & Average Export Scenarios 1-3 assume that exports largely track productions, resulting in flat stocks throughout 2Q17 and gradual increase over 2H17, though stocks are likely to remain below the psychological 2.0m MT level. Scenarios 4 and 6 assume exports lag behind productions, which lead to consistent stock build-up until year-end and closing stock levels pushing beyond the 2.0m MT mark in 4Q17. Meanwhile, scenario 5 assumes productions lag behind exports, leading to consistent stock drawdowns to year end. Of these possibilities, we think scenarios 2 and 6 have a higher possibility of occurring, as we expect full-year production closest to the “medium high” level. Hence, we believe the strength of exports will be the “wild card” which affects stock levels and thus prices. Meanwhile, we believe Scenarios 1 and 4 are unlikely as 2017 productions should fall short of 2015 numbers (19.96m MT); while Scenario 5 is also less plausible as exports tend to come in below monthly production figures.

Stock study indicates CPO prices have peaked. Following up on our earlier analysis between stock and CPO price movement (refer to page 1), we extend our stock scenarios to hypothetical price movements. Our study shows that in all likelihood, CPO price has already seen its full-year high at RM3,348/MT in mid-Feb 2017. We expect that with stock recovery in 2H17, prices will adjust down accordingly. Recall that we believe scenarios 2 and 6 have a higher probability of occurrence. In the price projection, scenario 2 would result in a broad but relatively high price range between RM2,700-3,200/MT. However, in the event of flagging exports, scenario 6 produces the weakest price outlook, with consistent price downtrends up to a possible low of RM1,800/MT by year-end. However, note that, our price projections are purely based on stock-to-price movements; but CPO prices could still see other positive or negative catalysts emerging in 2H17 that would affect the on-going supply-side downward price pressure.

El Nino risk still relatively low. Recent palm oil conventions have discussed the possibility of El Nino as a price catalyst in 2H17, but we take a wait and see approach as forecasters acknowledged the high degree of uncertainty in early-year forecasts. The US Climate Prediction Center (CPC) forecast indicates that the probability of El Nino would hit 50% from Sep 2017 onwards, while the Australian Bureau of Meteorology (BOM) expects El Nino-level temperatures from Apr 2017 onwards, although they noted that “model outlooks made at this time of the year are not as accurate as those made during the second half of the year”. Despite the likelihood of higher temperatures in 2H17, we are less concerned over the short-term as the ASEAN Specialised Meteorological Centre (ASMC) in its seasonal climate forecast expects largely normal to above-normal rainfall over the Malaysian & Indonesian region between Mar to May 2017, which should limit the drought aspect of El Nino. Nevertheless, the confirmation of moderate or strong El Nino with accompanying low rainfall could provide some price support towards year-end.

Biodiesel hinges on policies. Biodiesel outlook in 2017 will be more focused on governmental policies than usual, particularly in Indonesia, Malaysia, USA and Europe. Some planters have recently mentioned that Indonesia is considering a lower biodiesel margin for blenders from USD125/MT currently to USD100/MT. This could be supportive of CPO prices as slightly soften blenders’ margins would be compensated by higher subsidised biodiesel volumes. Meanwhile, Malaysia is targeting to implement B10 biodiesel blend this year from B7 currently. While a higher blend would improve domestic demand, we note that the B10 implementation has seen several delays since last year while a new implementation date has yet to be announced. Furthermore, the US government is mulling a switch in its Renewable Fuel Standard (RFS) point of obligation from refiners to blenders while easing sales restrictions on ethanol blends – the latter likely positive for sales volume, but the former could be risky due to lack of infrastructure. Finally, the EU could be moving to restrict the use of vegetable oils in biofuels, which could put a dampener on export demand. Overall, we think that Malaysia and Indonesia’s on-going biodiesel plans should bode well for prices, once implemented; but US and EU actions could be mixed-to-negative. Nevertheless, regional producers’ actions should provide price support for CPO prices that can negate actions from the US or EU, once it materialises.

Potential positive for CPO as availability risks offsets weak soy price. The US Department of Agriculture (USDA) in its latest World Agricultural Supply and Demand Estimates (WASDE) report has lowered its soybean oil price forecast for the 2016/17 season by USD¢2.0 to USD¢32-35/bushel (bu.) on a higher stock outlook. However, with recent events raising the possibility of a trade war between China and USA, we think that restrictions on US-China soy trade such as tariffs could have positive implications for South American soy and palm oil prices.

Support on range-bound crude oil and strong USDMYR. We think that flattish crude oil price and a strong USD should have a cushioning effect on CPO price downside in 2017. In line with our in-house 2017E average of USD55/barrel (bbl), we expect crude oil prices to continue trading at the current range of USD50-55/bbl over the mid-term as OPEC cuts are offset by persistently high US stocks. With the Indonesian biodiesel policy in place, we think that relatively stable crude oil prices should limit downside risk should CPO prices start declining, as higher volumes of CPO would then be subsidized and processed into biodiesel. Meanwhile, 2017 USD/MYR expectations (our in-house forecast: USDMYR4.35) remain well above 2015 numbers, which provide price support as CPO prices for export are quoted in USD.

KLPLN range trading against FBMKLCI. The KLPLN is currently trading slightly below the FBMKLCI with KLPLN’s 3-year total return of -7.5% against the KLCI’s -6.1%. This represents a 1.4% discount or -0.4SD against the historical average discount. We observe that since CPO prices ran up beyond RM2,800/MT in Oct 2017, the KLPLN has been trading range bound against the KLCI between +0.5SD and +1.0SD. With CPO prices currently hovering at c.RM2,900-3,000 /MT, we think the range trading pattern will hold over the near-term. Hence, at this range we expect the KLPLN to trade between 8,160 to 8,340 pts in the near term, implying limited downside (0.2%) and slight upside (+2.0%).

Expect solid 1Q17 earnings. YoY, we expect to see stronger 1Q17 earnings, thanks to a double boost of higher prices (+31% to RM3,172/MT quarter-to-date (QTD) average) and stronger expected Malaysian production (+17% to 3.98m MT). Meanwhile, QoQ earnings should be relatively flat, as higher CPO prices (+7%) offset lower expected Malaysian production (-16%). All-in, we think 1Q17 results should come in largely within-to-below expectations, depending on the strength of production recovery. Sabah-focused producers (ie: GENP; IJMPLNT, TSH, HSPLANT, UMCCA) may see some earnings weakness early in the year due to softer production, as they were more heavily impacted by dry weather in mid-2015 and early-2016.

2017 a year of earnings recovery but may have been priced-in. Although planters’ share prices tend to track CPO price movements, investors can take comfort in the positive sector earnings outlook for 2017. We believe that for 2017 planters will see strong earnings recovery at +52% at the sector level, compared to the substantial earnings drop seen in 2015 of -46% due to extended weak prices, despite a strong production year. We think this factor should help limit downside risk on planter’s share price, should CPO prices see a significant turnaround in 2H17. Nevertheless, with consensus CPO expectations at c.RM2,600/MT close to our own forecasted RM2,550/MT, we think that the earnings recovery trend has already been priced in to market expectations.

Planters share price likely range-bound, pending catalysts. Assuming the status quo, we expect planters’ share prices to be range-bound for the year, as the negative effect of declining CPO prices is offset by stronger earnings outlook and cost improvement thanks to rising production. However, several catalysts could provide a boost for selective stocks. For instance, changes in Indonesian biodiesel policy could benefit Wilmar, which is among the largest biodiesel producers in the country, and this by extension improves PPB’s prospect. Meanwhile, should US-Chinese soy trade suffer, we would expect to see a pick-up for planters, particularly larger caps with existing direct revenue streams from China such as SIME, IOICORP and KLK.

Maintain FGV at MARKET PERFORM (from UNDER REVIEW) with higher TP of RM2.10 (from RM1.85). On 21-Mar, following news reports of Chinese companies looking to buy into FGV, we placed our call and TP on FGV UNDER REVIEW from MARKET PERFORM at RM1.85. On 22-Mar, FGV management highlighted that they are “looking for a business partner for a long-term partnership” which “is expected to be finalised in the next 1-2 months”. We gather that its prospective partner would be expected to invest in the business and jointly explore the distribution in its home country. While we are not able to update our earnings due to the preliminary nature of the news, we expect any contribution to come in over the longer run. Nevertheless, with local media such as The Star and The Edge reporting that prospective partners are keen on an investment stake in FGV, we expect buoyed market interest to support the share price. Thus, we increase our TP to RM2.10 (from RM1.85) on higher Fwd. PBV valuation of 1.3x (from 1.15x) on unchanged FY17E BV/share of RM1.61. We update our valuation basis from 1.15x (-0.5SD valuation) to 1.3x, slightly under the mean valuation (of 1.4x) as production expectation (+5%) is still below average (+8%). However, the increase accounts for the potential earnings synergies on a foreign distribution partnership and better investor sentiment. Nonetheless, as FGV’s Upstream segment production improvement could be offset by muted Sugar business performance, we maintain our MARKET PERFORM call on the stock for now.

Maintain NEUTRAL with unchanged FY17E CPO price of RM2,550/MT. We maintain our NEUTRAL call on the sector as we believe CPO price upside is limited by a strong palm and soy production outlook, although downside is contained by rangebound crude oil prices and a strong USD/MYR. We continue to expect mild CPO price corrections in 2Q17 and a stronger correction through 2H17 as stocks start to recover, for a 2Q17 CPO price range of RM2,700-2,970/MT. However, external catalysts could lead us to revise our CPO price view. Assuming the status quo, we think planters’ share prices should trade range-bound with lower CPO prices offset by better production-led earnings. However, changes in Indonesian biodiesel policy could benefit Wilmar (and therefore PPB (MP; TP: RM17.60)), while a pickup of Chinese demand could benefit large caps such as SIME (MP; TP: RM9.50), IOICORP (OP; TP: RM5.15) and KLK (MP; TP: RM26.00).

Source: Kenanga Research - 29 Mar 2017