We came away from a meeting with UMCCA’s CFO, Mr. Young Lee Chern, encouraged by its FFB recovery prospect (11-17%) in FY20. CPO price is expected to range between RM1,900-RM2,100/MT, while costs are expected to improve (by c.RM200/MT) in FY20 to RM1,800/MT. Narrow FY20E CNL to RM7.5m and raise FY21E CNP to RM9.5m. Upgrade to MARKET PERFORM with a higher Target Price of RM5.00.

FFB recovery seen in FY20… Management is expecting FFB to grow by 10-15% for Malaysia and 20-30% for Indonesia for FY20. This should translate into 11-17% overall FFB growth for FY20, higher than our FY20 forecast (376k MT or +6%). We believe that management’s FFB growth expectations of 10-15% FFB in Malaysia is backed by a full recovery from El Nino and higher production from young trees in Keningau (c.8 year-old), while the 20-30% FFB growth in Indonesia should stem from its young age profile.

…but still cautious on CPO price outlook. Management expects CPO price to range between RM1,900-2,100/MT in 2019 (in line with our 2019 forecast of RM2,000/MT) as (i) implementation of biodiesel mandate in Malaysia and Indonesia remains slow, and (ii) exports volume is likely to soften (from lower demand and potential increase in India’s import tax). We agree that export volume is likely to come under pressure in 2H, given above-average buying activities for the months of Jan-May 2019 (1.6-1.7m MT; except Feb). In fact, based on June data, exports volume already exhibited a decline to 1.38m MT (MoM: -19%). Coupled with seasonal pick-up in production, this should lead to burgeoning stockpiles (likely 2.5-3.0m MT) by year-end, capping CPO price upside.

Improvement in costs in FY20. We believe cost could improve in FY20 to c.RM1,800/MT (from c.RM2,000/MT in FY19) attributed to: (i) strong FFB growth (11-17%), (ii) stable fertilizer costs at c.RM1,100- RM1,200/ha, and (iii) lower transportation costs due to shorter distance to its new palm oil mill in Indonesia (c.30km from estate vs. previously c.120km). However, we expect the group to remain in the red for FY20, due to unfavourable CPO prices. Meanwhile, the group’s new mill (FFB processing capacity: 45MT/hour) commenced in June-2019 and is expected to expand its total milling capacity by c.56% to 125MT/hour. Assuming an oil extraction rate (OER) of 21% and utilisation rate of 40% in FY20, we estimate that the new mill could contribute an additional RM31m in revenue for FY20.

Narrowed FY20E CNL to RM7.5m while raising FY21 CNP to RM9.5m (from CNL of RM6.6m) as we increase FY20-21E FFB output higher by 4%/4% to 392k MT/403k MT and tweaked transportation costs lower by 11%/11%.

Upgrade to MARKET PERFORM with a higher Target Price of RM5.00 (from RM4.90) based on an unchanged Fwd. PBV of 0.62x applied to CY20E BV/share of RM8.02. We believe at this level, the negatives could have mostly priced in and earnings turnaround is on the cards in FY21 on (i) more favourable CPO price (Our 2020 forecast: RM2,200/MT) and (ii) further cost improvement to RM1,700-1,750/MT as FFB yield in Indonesia improves. Our Fwd. PBV valuation is based on a steep -2.0SD from the 3-year historical mean (universe range: - 2.0SD to 1.0SD), given depressed CPO price environment and seven quarters of earnings disappointment.

Source: Kenanga Research - 24 Jul 2019