We recently attended the Global Timber Conference 2017 and met up with the Sarawak Timber Association (STA) and the Sarawak Timber Industry Development Corporation (STIDC), coming away with a better understanding of industry challenges, while being cautiously optimistic on certification measures, potential for FTA and new technology developments. The Sarawak timber sector has a stronger emphasis on primary and secondary products in contrast with West Malaysian which focus on furniture exports. This has led to lower volumes as the Sarawak State Government has made forest management certification mandatory. The lower volumes, combined with higher minimum wage, labour shortage and cost of verification have led to higher unit costs, which could depress timber earnings in the near term unless buyers are able to pay the appropriate premium for certified timber. Within the timber space, we have a MARKET PERFORM call on TAANN (TP: RM3.50) given the short-term weaknesses in its Timber segment due to soft volumes, although this is offset by strong production and robust prices in its Plantation sub-segment. Other calls for the Plantation sector include: OUTPERFORM on IOICORP (TP: RM5.00), PPB (TP: RM18.65), TSH (TP: RM2.00), UMCCA (TP: RM7.15), CBIP (TP: RM2.20) and SAB (TP: RM5.25); and MARKET PERFORM on SIME (TP: RM9.40), KLK (TP: RM26.35), GENP (TP: RM10.30), FGV (TP: RM1.95), IJMPLNT (TP: RM3.15) and HSPLANT (TP: 2.80).

Global Timber Conference 2017. We recently attended the Global Timber Conference 2017 which was held at Pullman Kuching in Sarawak between 6 – 8 November. The event was well attended by c.120 participants from the global timber industry and covered topics including: supply/demand prospects; genomics and good silvicultural practices; standards, certifications and eco-labeling; alternative raw materials; urban transformation; and wooden furniture trends. We also met the Sarawak Timber Association (STA) and the Sarawak Timber Industry Development Corporation (STIDC) and came away with a better understanding of key industry challenges, while still optimistic on the sector, should industry participants successfully implement certification initiatives and further develop their timber processing capabilities.

Sarawak and West Malaysia, a story of volume vs. value. Sarawak dominates log production in Malaysia with 7.4 cubic meters (m3) making up 54% of the national total output (13.7m m3). In comparison, West Malaysia made up 33% of Malaysian log production in 2017. However, in terms of timber product value, the story is reversed, with West Malaysia making up 65% of total Malaysian wood product exports while Sarawak comprised only 27%. We gather that this is due to Sarawak’s focus on primary and semi-finished timber products such as logs, sawn timber and plywood, while West Malaysia has stronger emphasis on wooden furniture exports.

Times are changing. We believe that the shift towards sustainable forest management units (FMUs) and plantation forests will herald lower production volume, although this should be offset by better premiums on certified timber. STA noted that Sarawak log production has trended downwards in recent years (with an 8-year CAGR of -6%) as the state government lowered export quotas to 30% in mid-2016. However, this was partly offset by substantial growth in production volume from planted forests; from nearly nil in 2014 to 1.3m cubic meters (m3) in 2016 and potentially c.24% growth in 2017, based on annualised 1H17 production. Mr Richard Laity (PEFC South-East Asia) noted the importance of certification as a pathway to international markets, while STA pointed out that Sarawak intends to make mandatory the Sarawak Timber Legality Verification System (STLVS) standard and Forest Management Certification (FMC) Policy for the Heart of Borneo initiative – an area covering 220k km2 region in Sabah, Sarawak, Brunei and Indonesia. With these initiatives, we believe sustainable harvested timber from FMUs and plantation forests that have achieved certification should yield better prices from higher-end markets, which should offset the volume limitations from sustainable harvesting methods.

Challenging cost environment. Given the decrease in log volumes, STA noted that unit cost of production is on a rising trend. Other cost factors include: rising premiums and royalties; raw material shortage at mills; higher cost of verification; higher minimum wages; and lack of manpower. Unless market prices adjust for lower supply, we expect cost factor to remain a risk to timber companies’ earnings in the near-to-medium-term, especially if buyers are unwilling to pay the appropriate premium for certified timber products.

Pockets of opportunities exist. In spite of the current challenging market, we believe timber players can still find opportunities in the market to improve long-term prospects. Dr Amalina Ahmad Tajudin (Universiti Sains Islam Malaysia) noted that the RCEP FTA between ASEAN and six countries (Australia, China, India, Japan, South Korea and New Zealand) could provide better market access for Malaysian timber in spite of diminishing prospects of TPPA. Meanwhile, Prof. Dr. Zakiah Ahmad (Universiti Teknologi Mara) and several speakers pointed out the case for expanded use of timber through engineered products such as glulam and Cross Laminated Timber (CLT) which can even be used for high-rise construction with properties similar to steel and concrete. The industry could also harness new technology to improve production efficiency, with Mr. Arif Makhdzir (Braintree Technologies) demonstrated the use of drones for tree surveys, stockpile count and plant fertilisation among others. Lastly, the STA also mentioned its work with various universities to speed up tree growth and improve wood consistency to improve returns at timber plantations. We believe these measures could provide good long-term opportunities to a nimble timber player.

Cautiously optimistic amidst a sea change. In spite of the daunting challenges faced by the timber industry, including log quotas and rising cost factors, we returned from the conference with a cautiously optimistic view on the sector as certification could provide a path to better pricing power, while longer-term opportunities such as FTAs, better use of technology and research into new products and silviculture could strengthen the outlook for the sector. In the timber space, we have a MARKET PERFORM call on TAANN (TP: RM3.50) given short-term weaknesses in its Timber segment due to soft volumes, although this is offset by strong production and robust prices in its Plantation sub-segment.

Source: Kenanga Research - 10 Nov 2017