We came away from a meeting with UMCCA’s CEO, Mr. Peter Benjamin, maintaining our cautious stance. FFB output is expected to decline 5-6% in FY19, while CPO price is seen at RM2,200-2,300/MT. Its new mill in Indonesia will expand capacity by 56% and likely to generate additional revenue of RM27m. Raise FY20E CNP to RM26.7m considering the new mill’s contribution but maintain FY19E CNL of RM11.5m. Downgrade to UNDERPERFORM with a higher TP of RM5.10.

Soft output growth in FY19, recovery seen in FY20. Management guided FFB growth of 20% in Indonesia, -5% in Peninsular Malaysia and -15% in Sabah for FY19. Overall, this should translate to a 5-10% decline for FY19, in line with our -6% forecast. The precipitous drop expected in Sabah is due to an old age profile in its Meridian plantations – about half of the palms are aged above 18 years. However, after a year of lacklustre output, the group is expected to register 15% FFB growth in FY20, with 20% growth in Indonesia due to young age profile and 10% growth in Malaysia due to a full recovery from El Nino and young trees in Keningau (c.8-year-old).

Cautious on CPO price outlook. Management expects CPO price to range from RM2,200-2,300/MT in 2019, as stockpiles are expected to rise to 3.4-3.5m MT by year-end, while soybean oil supply in China will likely increase if the trade war eases and India may have intentions to protect its local farmers. Management also questions the effectiveness of biodiesel initiatives in both Malaysia and Indonesia. On the other hand, we are sticking to our slightly more bullish CPO price target of RM2,400/MT for 2019 as in our opinion, easing trade war would support US soybean oil prices and also CPO prices (refer overleaf).

Cost to recover only in FY20. Cost of production is expected to rise to RM2,000/MT in FY19 from RM1,800/MT in FY18, due to higher maintenance costs for newly matured palms – c.7k Ha came into maturity in FY18. Coupled with unfavourable CPO prices in 2HCY18, we expect the group to register its first-ever losses in FY19 (as concurred by management). It has been reporting losses for the past two quarters, and is likely to remain in the red in 3Q19. Nevertheless, we believe cost will improve in FY20 to RM1,600/MT due to strong FFB growth while steady increases in wages have a minimal impact on earnings. Fertiliser costs have also remained stable at c.RM1,800/Ha, though the group has not locked in its FY20 requirements.

New mill expansion. The group is adding one palm oil mill in Indonesia that comes with processing capacity of 45MT of FFB per hour, which is slated to commence in May 2019. This will expand its total milling capacity by c.56% to 125MT/hour, from 80MT/hour currently. Although its Indonesian FFB output can only fill up c.15% of the new mill’s capacity, we note that the group can source external FFB from neighbouring estates to improve utilisation. By conservatively assuming an oil extraction rate (OER) of 18% and utilisation rate of 30% in FY20, we estimate that the new mill can contribute additional RM27m revenue (10% of FY20 revenue) in the next financial year.

Raise FY20E CNP to RM26.7m (from RM1.4m) on account of the new mill’s contribution; while maintaining FY19E CNL of RM11.5m.

Downgrade to UNDERPERFORM with a higher TP of RM5.10 (from RM5.05) based on an unchanged Fwd. PBV of 0.61x applied to higher CY19E BV/share of RM8.37 (from RM8.29). The Fwd. PBV is based on -3.0SD from the historical mean, given that the company has disappointed expectations five quarters in a row, and near-term earnings are likely to be impeded by high maintenance costs for young trees in Indonesia. Despite the new mill’s contribution, share price has recovered noticeably from the lows and in our opinion, it no longer warrants a MARKET PERFORM call. We may relook at our valuation basis if developments turn more positive post-FY19.

Source: Kenanga Research - 04 Feb 2019