We downgrade the plantation sector to NEUTRAL with a lower CY20 CPO price target of RM2,550/MT (from RM2,700/MT) following a series of setbacks, namely: (i) COVID-19 drag on demand, and (ii) crude oil price nose-diving by >30%. Until the COVID-19 infection dissipates, Chinese palm oil demand is likely to remain muted. There is now uncertainty (due to the wide POGO spread of c.USD187/MT) surrounding the implementation of biodiesel mandates and in an event of failure to implement B30, it would effectively mean an additional CPO supply of 2.5-3.0m MT (which the street is not expecting) flooding the market. This challenges our initial view of demand-supply tightness for CPO in 2020. Given the uncertainty, we expect a de-rating in planters’ valuations and we now ascribe -1.0SD to -0.5SD valuations (from +1SD) to planters under our coverage. Having said that, while CPO price has indeed fallen, it is worthwhile to mention that it is still 10% higher than 2019’s average, which should translate into earnings improvement. For investors seeking exposure to the sector, we recommend bashed down names like HSPLANT and KLK. KLK’s downstream division also offers reprieve as the fall in CPO prices translates to lower feedstock prices. Meanwhile, February 2020 inventory (-4.2% MoM) was largely within our/consensus’ estimates (-5.5%/-1.4% MoM). Production rose (+10.0% MoM), a larger-than-expected increase compared to our estimate (+4.7% MoM), but within consensus’ (+9.3% MoM). Exports (-10.8% MoM) came within our/consensus’ estimate (- 7.7%/-11.4% MoM) For March, we forecast: (i) production recovery to continue (+8.4% MoM) as trees continue to recover from stress, and (ii) exports to rise (+5.8% MoM) ahead of the Ramadan season and as winter draws to an end. Exports to India and China are still expected to remain muted. All-in, we project total demand (1.46m MT) against additional supply (1.46m MT) leading to flat ending stocks of 1.70m MT (-+0.8% MoM) in March.

Risks emerge; A series of unfortunate events. We downgrade the plantation sector to NEUTRAL (from OVERWEIGHT) with a lower CY20 CPO price target fo RM2,550/MT following a series of unfortunate events, namely: (i) COVID-19 drag on demand, and (ii) the collapse of OPEC+ resulting in crude oil price plunging >30%.

COVID-19 dealt the first blow. The global markets started to sell off in January 2020 on fears of the impact of COVID-19 and CPO was not spared. YTD, CPO prices have fallen 26% and one of the main reasons lies with the decline in Chinese palm oil demand. To put things into perspective, YTD (2MCY20) Malaysian palm oil exports (2MCY20) to China have fallen 17% and until the virus infection dissipates, palm oil demand from China is likely to remain subdued. The only silver lining in this (although unlikely - given China’s soybean purchase pledge) is the possibility of pent-up demand over the consecutive low-buying months resulting in backloaded palm oil demand from China once COVID-19 infection dissipates.

Double whammy by crude oil price’s plunge. The collapse of OPEC+ resulted in a nosedive of crude oil prices (>-30%) and correspondingly caused palm oil-gasoil (POGO) spread to widen to USD187/MT from an already alarming USD131/MT at the start of 2020. This gives rise to uncertainty in terms of the implementation of biodiesel mandates (especially Indonesia’s B30 – lauded as the industry’s game changer). We are unable to ignore the possibility that in event of a failure to implement B30, it would effectively mean an additional CPO supply of 2.5-3.0m MT flooding the market – a drag to CPO price and challenging our initial view of demand-supply tightness for CPO in 2020.

Lower CY20 CPO price forecast; Valuations de-rating. Given the plunge in crude oil prices, we cut our CY20 CPO price target to RM2,550/MT (from RM2,700/MT). Post CPO price revision, we reduced planters’ earnings on average for FY20-21E by 12-13%. The lower CPO price has the most impact on pure upstream planters and planters with significant upstream portfolio, with the likes of HSPLANT, IJMPLNT, FGV, SIMEPLNT bearing the brunt of our earnings reduction (17-30%). On valuations, we believe the street has priced in a successful implementation of the biodiesel mandates and given the rising uncertainty around Indonesia’s B30, valuations de-rating is to be expected. Consequently, we adjusted ascribed valuations of our planters (from +1SD) to -1.0 to -0.5SD from mean (refer to exhibit 11).

Downgrade plantation sector to NEUTRAL as we view the uncertainty of implementation of biodiesel mandates as a de-rating catalyst. Having said that, we retained our OUTPERFORM call for small-mid planters as most are traded at below book value; the likes of HSPLANT and IJMPLNT are traded at merely around 0.75x Fwd. PBV, despite improvement in earnings. While CPO price has indeed fallen, it is worthwhile to mention that it is still 10% higher than 2019’s average of RM2,129/MT, which should translate into earnings improvement. For investors seeking exposure to the sector, we recommend taking positions in bashed down names like HSPLANT and KLK. KLK’s downstream division also offers reprieve as the fall in CPO prices translates to lower feedstock prices.

Source: Kenanga Research - 11 Mar 2020