Flat 2Q17. 2QCY17 results came in similar to 1Q17 with two stocks (TAANN, UMCCA) above consensus and our estimates, while three missed consensus (FGV, GENP and IJMPLNT) compared to two misses from our end (IJMPLNT and IOICORP). 7 and 8 stocks came in within consensus and our estimates, respectively. This is quite close to 1QCY17 performance with 2 above-market estimates, 8 within and 2 below expectations. YoY, planters continued to enjoy higher CPO prices averaging growth of 21% while production also recovered 4%, leading to earnings growth across the board averaging 32%. Only IJMPLNT saw weaker profit contributions due to lagged dryness effect in Sabah lingering from the mid-2016.

Prices holding up – but for how long? Inversed to rising stocks, YTD prices have softened 16% to RM2,730/metric ton (MT) against an estimated 36% increase in Sep 2017 stock level to 2.10m MT. Compared with 2016, CPO prices jumped 45% to RM3,200/MT in response to a 28% decline in stocks to 1.67m MT. We find that the degree of price movement in 2017, responding to stock increases is smaller than the degree of price appreciation in 2016 in response to stock drawdowns. We think this could herald downside price risk given the decent production and softer demand outlook to be elaborated below.

Invisible peak for 2017? In our channel checks with planters, we gather that although production to-date has been slower than anticipated, most planters surveyed indicated at least slight production improvement from September. While we understand that the high number of rainy days have impacted fruit collections, production volumes could well remain steady up to Nov 2017 before dipping seasonally in Dec 2017 to Feb 2018 during the traditional monsoon season. Assuming stable production c.1.90m MT from Sep-Nov and average production in Dec 2017, this will sum up to full-year production of 19.55m MT or +13% YoY.

Demand in charge? With a stable short-term outlook for production, demand remains as the main price driver over this period. We think that with the Mid-Autumn festival in early October and Diwali in mid-October, Chinese and Indian demand should remain robust for September. However, we see limited festival demand catalysts from mid-October onwards, leaving only re-stocking activity to support buying going into 4Q17. This will largely be dependent on price competition between CPO and its main competitor, soybean oil (SBO).

Tightening CPO-SBO discount. The SBO-CPO price discount widened significantly from near zero in Feb 2017 to over USD100/MT, though the spread on cash prices has tightened to under USD100/MT in the last two weeks as SBO prices rapidly fell from c.USD780/MT on 6-Sep down to c.USD730/MT by 26-Sep. In the key Rotterdam port, the difference has been sustained at USD150/MT, although we expect it to narrow in the coming days given the drop in SBO cash prices. A tighter SBOCPO discount would reduce the attractiveness and thus the demand outlook for CPO in the short term.

Waiting for biodiesel support. With the new normal of low crude oil prices, biodiesel demand is essentially driven by government mandates and policies. While the Indonesian biodiesel program continues to act as a price support mechanism should prices fall, we note that international uptake is very low, more so with anti-dumping duties of c.40% to be imposed on Indonesian and Argentinian biodiesel by the USA, and tightening vegetable oil biodiesel rules in the EU. This could lead to further supply buildup adding pressure to CPO prices in the months to come.

Bearish 4Q17 CPO price outlook of RM2,500/MT. With the stable production and risky demand outlook, we maintain our bearish outlook in 4Q17 with a forecast CPO price average of RM2,500/MT. This is premised on SBO prices of USD¢33.5/pound (lbs), despite improved crude oil expectation of USD54.5/barrel (bbl), while we expect stocks to close at 1.90m MT and USD/MYR to average 4.20 for the quarter. We expect the lingering El Nino production and stock impact to continue influencing market valuations through the rest of 4Q17, though this is likely to fade once stock levels pass the psychological 2.0m MT mark in the next 1-2 months.

However, upgrade FY17E CPO price to RM2,700/MT given strong YTD performance. We believe the strong YTD performance for CPO prices was largely due to the long-term production impact from 2015-16 droughts, which had a prolonged impact on both local and international palm stocks. In our multivariate model, increasing our weather multiplier to 1.0 (representing a weak effect, from no effect) increases the USD impact of CPO prices by c.USD40/MT. However, we lower our crude oil forecast to USD51/bbl (from USD54/bbl) and tweak up our USD/MYR forecast to 4.30 to reflect our latest in-house forecast. We also adjust down our SBO estimate to USD¢35.0/lbs in line with Bloomberg consensus estimates. Our year-end stock outlook is trimmed to 1.90m MT to reflect the lingering stock effect from soft production. Our Monte Carlo model suggests a 47% probability of CPO prices between RM2,500-2,800/MT, a 21% probability of prices under RM2,500/MT and 32% probability of prices over RM2,800/MT for the year. Taking the average forecast, we upgrade our FY17 CPO price estimate to RM2,700/MT (from RM2,550/MT).

Softer FY18E ahead with CPO price of RM2,400/MT. As stock levels recover over 4Q17, we expect price implications from weather to fade off in 2018, resulting in higher influence from SBO and crude oil on CPO prices. In line with our inhouse forecast, we expect FY18E crude oil prices to pick up to USD55/bbl while USD/MYR should further decline to average 4.20. In line with the Bloomberg consensus, SBO prices should pick up to USD¢36.0/lbs while ending stocks should rise to 2.14m MT in view of a stronger production outlook. Our Monte Carlo model suggests a 48% probability of CPO prices between RM2,200-2,500/MT, a 19% probability of prices under RM2,200/MT and 33% probability of prices over RM2,500/MT for the year. Taking the average forecast, we expect lower FY18E CPO prices of RM2,400/MT (-11%).

Expect limited earnings effect on FY17-18E as we observe that the earnings impact from “supernormal” price were largely negated by higher production costs, while gradually softening prices will be offset by rising production for better economies of scale. Overall, we adjust up FY17-18E earnings by an average of 4%, while reducing FY18-19E earnings by an average of 6%. With our valuation base year of CY18E across the board, this resulted in lower TP by an average of 3% across the board. Accordingly, we lower our call on HSPLANT and IJMPLNT to MARKET PERFORM while all other calls are maintained.

Better 3Q17 ahead, despite Sabah lagging. YoY, we expect to see better 3Q17 earnings as CPO prices have largely maintained its strength (+1% to RM2,677/MT as of 3Q17 quarter-to-date (QTD)) while we expect Malaysian production to rise 11% to 5.54m MT. QoQ, earnings should be flat-to-better on higher production (+17%) which should offset weaker prices (-3%). We expect best YoY improvement from planters focused in Peninsular Malaysia (SIME, IOICORP, KLK, FGV, UMCCA) for which we expect 19% YoY growth compared to Sarawak (+7%) and Sabah (-2%). For QoQ improvement, we think Peninsular Malaysia and Sarawak planters (TAANN) should see better growth of 21% and 22%, respectively, compared to Sabah’s +6% growth.

KLPLN range-bound vs. FBMKLCI. The KLPLN continued to trade below the FBMKLCI with a 3-year total return of -10.9% vs. the FBMKLCI’s -4.8%. This represents a 6.1% discount or -1.6SD against the historical average discount. In tandem with the CPO price downtrend since Feb 2017, the KLPLN continued to underperform the FBMKLCI, indicating that investors have little interest in the sector due to a weak CPO price outlook. Currently, the KLPLN is stable at -1.0 to -0.5SD against the FBMKLCI. Should CPO prices continue to angebound at current levels, we expect current trading levels to hold, corresponding to KLPLN levels of 7,740 to 7,910 pts in the near term. Note that at this level, downside at -1.7% is higher than upside of merely 0.4%.

Top Pick: PPB (OP; TP: RM18.65). We are positive on PPB’s mid-term outlook with its own businesses seeing new developments, including Grains segment’s new Pasir Gudang flour mill ready by end-2017; Film segment’s 9-location expansion both locally and overseas; and Property division launching its Taman Megah redevelopment with RM500m GDV by year-end. Its associate Wilmar should also see better 2H performance thanks to positive crush margins and rising palm yields. Further excitement could be seein in the restructuring of Wilmar’s soy crushing and consumer business, which could lead to a listing.

Bursa MidS Top Pick: SAB (OP; TP: RM5.25) based on Sum-of-Parts. Valuations are fairly undemanding at 16x PER for Plantation Upstream (small cap planters average), 15x for Oleochemicals (5% discount to small cap planters) and 18x for Healthcare (small cap Healthcare average) with conglomerate discount of 15%. Operationally, SAB enjoys above-average Oleochemical margins at c.5%, with less PK price-volatility on improving regional production, resulting in stable 5% operating margins in FY18-19. Meanwhile, the Healthcare segment is expanding its bed capacity (+20-20 beds in FY18-19E to 201 beds) and in a core discipline, for continued operating income growth (+18-11% to RM22.0-24.4m). Its strong balance sheet supports expansions at a net cash position of RM163.2m (RM1.19/share) which supports group capex of RM26m and dividend of RM6.8m (5.0 sen/share). Indeed, should SAB expand its estates, we estimate borrowing capacity up to RM450m (assuming 50% net gearing) supporting landbank expansion of 1.5-4.6x to 11.7-26.0k ha (7.1k ha brownfield/21.4kha greenfield).

Reiterate NEUTRAL. While we expect softer CPO prices in 4Q17, strong CPO prices to-date should support good YoY earnings growth. Higher full-year prices are offset by higher production cost due to soft yields in early-2017 though we expect this to improve in late-2017. Meanwhile, recovering stocks and ending festive season could dampen CPO prices in the near-to-mid term. Our top picks are: (i) PPB (OP; TP: RM18.65) on new developments in its Grains, Film and Property segments, while Wilmar could see excitement on its China operations restructuring, and (ii) SAB (OP; TP: RM5.25) due to undemanding valuations, natural hedge in its integrated plantation businesses, healthcare segment expansions and strong balance sheet.

Source: Kenanga Research - 5 Oct 2017