In 2H19, production is likely to pick up sturdily due to seasonality, while exports volume is likely to soften as we have already seen above-average buying for 5 consecutive months. Overall, we expect supply to outstrip demand in 2H19, leading to burgeoning stockpiles (likely reaching 2.5-3.0m MT level in 4Q19) and capping the CPO price upside. We believe planters under our coverage, especially the upstream players, will continue to undergo a rough patch in upcoming quarters with CPO prices hovering around current levels, overshadowing any production pickup in 2H19. Valuations remain unattractive as our planters are currently trading at, on average, -0.5SD from their respective mean PER/PBV vs. -2.0SD in 4QCY18, against a similar backdrop. The European Commission has recently drafted a regulation to limit palm oil consumption for biofuel use at 2019 levels up to 2023, and gradually reduce further through 2030 until an eventual phase-out. This is likely to continue hurting the sentiment and prices of CPO. A supporting factor, however, is the biodiesel mandates as Indonesia’s B20 programme is expected to absorb c.13% of the country’s CPO production while Malaysia’s B10 should take up c.4% of our local output. All-in, we believe CPO prices will remain under pressure in 3Q19, potentially trading in the range of RM1,800-2,100/MT. Reiterate UNDERWEIGHT on the Plantation sector with unchanged 2019 CPO price target of RM2,000/MT. Nevertheless, should the Chinese and/or biodiesel demand be stronger than-expected, resulting in falling stockpiles in 2H19 and a sharp recovery in CPO prices, we would review our sector call and TPs of planters under our coverage.

3Q19 still dim. While some positive factors are developing in the plantation sector, an expected rise in stockpiles in 2H19 and negative news flows have diffused negative sentiments and weighed on CPO prices, dampening near-term prospects of planters under our coverage. Coupled with unattractive valuations, we are maintaining our UNDERWEIGHT stance on the plantation sector with an unchanged 2019 CPO price target of RM2,000/MT.

Stockpiles to pick up in 2H. From our checks with a few local planters, we gather that there has been no weather issue in palm estates in large and hence, production is likely to pick up sturdily in 2H as per usual (from 1.5-1.7m in the past few months to 1.8-2.0m in 4Q19). On the exports front, we have already seen above-average buying for 5 consecutive months, thanks largely to record-high demand from India after the import levy reduction in January 2019 as well as bulky China purchases due to its pledge to up palm oil imports. However, the buying frenzy is likely to dissipate in 2H19 as the palm oil inventory of the two major importers build up (China: 825k MT in May 2019 vs. 400-500k MT in 2H18; India: 652k MT in May 2019 vs. 400-600k MT in 2H18). Overall, we expect supply to outstrip demand in 2H19, leading to burgeoning stockpiles (likely reaching 2.5-3.0m MT level in 4Q19) and capping the CPO price upside.

Weaker results to linger. We believe planters under our coverage, especially the upstream players, will continue to undergo a rough patch in upcoming quarters with CPO prices hovering around current levels, overshadowing any production pickup in 2H19. Nevertheless, we still expect earnings to fall within our expectation as the negatives have already been accounted for in our latest earnings adjustments. Having said that, we believe potential exceptions are (i) IOICORP, as its oleochemical margins are likely able to sustain on stable demand for specialty products and (ii) PPB, as soybean crush margins are likely to improve when the adverse effect of the African swine fever outbreak subsides.

Valuations remain unattractive; seeing downside to street estimates. Planters under our coverage are currently trading at, on average, -0.5SD (range: -1.5 to +1.0SD) from their respective mean PER/PBV. Notwithstanding, we believe the current valuations are still unwarranted as the companies were mostly trading at -2.0SD in 4QCY18, during which CPO price was hovering around RM1,700-2,100/MT (similar to the current situation). Furthermore, we see downside risks to street earnings estimates as our current earnings forecasts are, on average, 17% below those of consensus’. We also underscore that the heyday of high ROEs is observably over for planters (see Exhibit 4), which reinforces our view that valuations could derate further. These are likely to take a toll on most planters’ current share price in 3QCY19.

Source: Kenanga Research - 5 Jul 2019