We maintain our NEUTRAL outlook for 3Q17 as prospect of weaker price is offset by better planters’ earnings on the back of strong production and decent demand outlook. Our FY17E CPO price is unchanged at RM2,550/metric ton (MT) although 2H17 prices are likely to average below this figure given strong 1H17 performance. Recent price declines are in line with our bearish projections for stock improvements, while production appears on track to meet 19.95m MT, matching 2015 all-time high of 19.96m MT. Nevertheless, a better CPO vs. soybean oil (SBO) discount should benefit demand and support prices. Meanwhile, those looking to biodiesel and weather to prop prices may be disappointed. Other risks include US and EU biodiesel investigations that may hurt export demand in the longer term. Our CPO-price based PER estimators indicate planters’ share prices downside of c.7% at CPO prices of RM2,200/MT and c.13% should CPO prices tack down to RM1,800/MT. Nevertheless, we still expect earnings improvement in 2Q17 thanks to higher CPO prices and Malaysian production recovery. In a declining price environment, we think big-caps with downstream facilities such as IOICORP (OP; TP: RM5.50), KLK (MP; TP: RM26.56) and PPB (OP; TP: RM19.35) through its associate, Wilmar, should benefit from lower input costs. We also like efficient planters with above-average production outlook such as IJMPLNT (OP; TP: RM3.60), TSH (OP; TP: RM2.18) and UMCCA (OP; TP: RM7.70) to offset a weaker price environment. Other calls & TPs include: HSPLANT (OP; TP: RM2.90), SIME (MP; TP: RM9.50), GENP (MP; TP: RM12.40), FGV (MP; TP: RM1.85), TAANN (MP; TP: RM3.60), and CBIP (MP; TP: RM2.20).

A better 1Q. 1QCY17 results improved QoQ, as two stocks (KLK and UMCCA) exceeded consensus while three beat our estimates, and only two missed both consensus and our forecasts (FGV and IJMPLNT). This compares favourably to 4QCY17 with 2 above market estimates, 6 within and 4 below expectations. All planters benefited from higher prices, ranging from 23-39% YoY increase with generally lower gains for companies with higher percentage of forward sales. YoY production recovery was mixed, as some were impacted by early 2015 El Nino in Sabah, resulting in a broad production range of -7% to +29%. GENP and TAANN led the pack at 29% and 25% growth, respectively, thanks to younger production area.

1H17 KLPLN and CPO price review. While CPO prices started the year maintaining its upward trajectory, prices rapidly corrected in Feb 2017 as stock levels stabilised. Despite a high 1H17 average price of RM2,952/MT, CPO price declined 19.7% to RM2,619/MT by our report cut-off date (23-Jun-2017) from the start of the year. Despite the CPO price decline, the KLPLN saw a slight appreciation (+1.8% to 7,930 pts) due to anticipated performance improvement and better market sentiment, but the index underperformed the FBMKLCI which saw an 8.8% appreciation to 1,779 pts.

Price decline in line with rising stock outlook. Recall in our previous 2Q17 strategy (published 29-Mar-2017), we outlined our production and demand scenarios to form six potential stock outlooks for 2017. On the hypothesis of CPO prices inversely tracking stock movement, we used our stock scenarios to project potential price movements for the year. Of our price scenarios,

2Q17 CPO price performance has mostly tracked our bearish projections (Scenarios 4 and 6), indicative of exports trailing below production increases. Should weak demand trends persist, we think that our weak outlook outlined in scenario 6 could hold, with downtrend to a potential low of RM1,800/MT by year-end. Nevertheless, we highlight that our price projections are purely based on stock-to-price movements, but other catalysts could emerge in 2H17, which would affect the overarching supply-side downward price pressure.

Production on track to hit 19.95m MT in 2017. We estimate 1H17 production at 8.86m MT, which comes in at 98% of the average between the 5-year average and 5-year high 1H production figure of 9.02m MT. With production closely tracking “medium-high” historical patterns, we estimate full-year production to be on track to hit 19.95m MT, or +15% YoY and very close to 2015 all-time high of 19.96m MT, assuming planters are able to maintain adequate harvesting labor force during the upcoming peak production season.

Modestly higher CPO-SBO discount benefits demand. Against its closest competitor, SBO, the CPO price discount has gradually widened from near zero in Feb-17 to c.USD75/MT. Although this is lower than the long-term historical average discount of c.USD140/MT, the wider discount could prove attractive to price-sensitive buyers in China and India. Looking ahead, we expect the CPO-SBO discount to maintain or widen as production kicks in over 2H17. A higher discount coupled with better CPO availability should have a positive demand impact going into 2H17.

Flattish Indonesian biodiesel volume unlikely to support near-term prices. Indonesian biodiesel allocation of 1.37m kiloliters (kl) (c.1.21m MT) for May-Oct 2017 was announced recently, lower than the Nov-2016 to Apr-2017 allocation of 1.53m kl (c.1.35m MT). By annualising this figure, we estimate Indonesian subsidized biodiesel volumes of 2.89m kl (c.2.52m MT), slightly lower than 2016 subsidized biodiesel allocation of c.2.60m MT. The reduction is likely due to higher input cost (CPO prices) in early 2017. Meanwhile, reports from The Jakarta Post (19-Apr) indicate that the proposed reduction in biodiesel conversion cost of USD100/MT from USD125/MT, although agreed to in principal, is yet to be implemented in the May-Oct 2017 allocation as additional simulations and revision of presidential regulations are needed. Should the lower conversion cost be implemented in the coming allocation period (Nov 2017 to Apr 2018), we would expect to see higher biodiesel quotas, supporting prices in early 2018. However, the lower allocation presently is unlikely to catalyst market in the short term.

EU & US biodiesel investigations pose risks. Further abroad, ongoing moves to curb CPO use in biodiesel could prove longterm negative for price support. The EU continues its efforts to phase out vegetable oils for biodiesel by 2020, which we gather is being challenged by the Malaysian and Indonesian government at the World Trade Organization (WTO). On the US side, biodiesel policy reforms and petitions from US biodiesel bodies could lead to reduced US biodiesel imports and potentially antidumping duties on Argentinian and Indonesian biodiesel. While duties might increase local US soybean prices (which is positively correlated to CPO prices), lower biodiesel imports would lead to higher supply of soy and palm biodiesel, a price negative factor which we think would offset any potential gains on duties.

Appreciating ringgit lessens price cushion. Since the previous CPO price low of RM1,806/MT (USD427/MT at USDMYR4.23) in Aug-2015, CPO prices in RM terms have improved 45.0%, which is only 1.8% higher than CPO prices in US terms which improved 43.2%. The percentage price difference is well below the peak CPO price of RM3,348/MT (+85.4%) or 8.7% higher than USD CPO prices of USD752/MT at USDMYR4.44. Given the strong positive correlation between CPO prices (RM) and USD/MYR (c.95% since Aug-15), the ringgit appreciation to USDMYR4.29 (from a peak of USDMYR 4.50 in Jan-17) reduces forex support for CPO prices. Hence, we think continued RM appreciation may not bode well for CPO prices, particularly in a CPO price downtrend scenario: should prices decline to 2015 USD lows, current USD/MYR of 4.29 corresponds to CPO prices of RM1,830/MT which is hardly different from the previous low of RM1,806/MT.

Weather outlook neutral. In 2H17, we expect weather to play a minimal role in CPO price movement. Both the US Climate Prediction Center (CPC) and Australian Bureau of Meteorology (BOM) models indicate higher changes of neutral weather in 2H17, with the US CPC having slightly higher odds for a weak El Nino development (c.35% by year end) while the BOM outlook is mainly neutral. With diminishing risk of El Nino and a generally normal weather outlook, we expect production patterns to progress as anticipated with limited risks in 2H17 and 2018.

KLPLN range trading against FBMKLCI. The KLPLN is currently trading below the FBMKLCI with KLPLN’s 3-year total return of -10.3% against the KLCI’s -4.0%. This represents a 6.3% discount or -1.6SD against the historical average discount. In tandem with the CPO price downtrend since Feb-2017, the KLPLN has begun to underperform the FBMKLCI, indicating that investors are losing interest in the sector due to a weaker CPO price outlook. Currently, the KLPLN is relatively stable at -1.0SD to -0.5SD against the FBMKLCI. Should CPO prices are sustained at current levels, we expect the current range to hold, corresponding to KLPLN levels of 7,825 to 7,990 pts in the near term. At this level, downside at -1.3% is slightly higher than upside of 0.8%.

2Q17 earnings to continue improvement. YoY, we expect 2Q17 to deliver stronger earnings on the back of both higher CPO prices (+6% to RM2,755/MT) and stronger Malaysian production (+16% to 4.86m MT), while QoQ earnings should be flat-tohigher on seasonally better production (+21%) albeit softer CPO prices (-12%). Overall, we expect 2Q17 results to come in largely within expectations as we have already priced in production recovery for the year. Planters with good Peninsular Malaysia exposure such as SIME, IOICORP, KLK, FGV and UMCCA could see higher-than-average production growth trends as the region has seen decent rainfall patterns over the last year while 2016 production was weakened to a large extent by 2015 droughts.

Downside risk for planters’ share price. Given our expectation of lower CPO prices in 2H17, below are our CPO-price based PER model results for CPO prices at RM1,800/MT, RM2,200/MT and our full-year forecast of RM2,550/MT. On average, our model suggests planters’ share prices downside of c.7% at CPO prices of RM2,200/MT and downside of c.13% should CPO prices tack down to RM1,800/MT.

Reiterate NEUTRAL with unchanged FY17E CPO price of RM2,550/MT. While 2H17 CPO price outlook is likely weaker, note that we have incorporated this into our earnings forecasts. We expect lower CPO prices to be offset by rising production, which corresponds with lower production cost per ton, thanks to economies of scale. A decent demand outlook should help support CPO price downside, and potential catalysts include a weaker ringgit and wider price discount against SBO. In a declining price environment, we think big-caps with downstream facilities such as IOICORP (OP; TP: RM5.50), KLK (MP; TP: RM26.56) and PPB (OP; TP: RM19.35) through its its associate, Wilmar, should benefit from lower input costs. We also like efficient planters with above-average production outlook such as IJMPLNT (OP; TP: RM3.60), TSH (OP; TP: RM2.18) and UMCCA (OP; TP: RM7.70) to offset a weaker price environment.

Source: Kenanga Research - 6 Jul 2017