Stay NEUTRAL on the plantation sector as CPO supply-demand tightness remains relatively intact. Our CY2020 CPO price target of RM2,550/MT remains. Although Sabah palm operations suspension in 3 districts could create negative sentiment, the impact of minus 15 working days is unlikely to be significant on full-year FFB production as extended harvesting hours could make up for the loss. As such, we keep our FFB forecasts unchanged for now but a prolonged suspension or total lockdown of the country would prompt us to revisit our estimates. Chinese demand could wane due to: (i) China-U.S. soybean purchase pledge, and (ii) high Feb 2020 oil and fats ending stocks (+17.4% MoM) in China. Meanwhile, we are unable to ignore the possibility of a failure to fully implement B30. Based on our in house CY20 crude oil and palm oil assumption of USD40/brl and RM2,550/MT, Indonesia would be able to implement c.24% of its incremental B30 programme, upon full exhaustion of its biodiesel fund (with export levies collected). However, given how determined the country seems on driving biodiesel consumption locally, there is a possibility of that the country’s savings from lower crude oil import and prices could be channelled to the successful implementation of its B30 programme. That said, we believe CPO supply-demand tightness remains relatively intact as the expected decline in demand should be offset by an expected dip in production. On valuations, given the increasingly profound risk-off environment and escalating uncertainties surrounding demand, we adjusted ascribed valuations of our planters (from -0.5SD against mean) to -1.0SD from mean. Even after our valuation de-rating across the board, we see a window of opportunity here for investors to bottom fish selected names that are currently traded (report cut off date: 20 Mar 2020) at -2.0SD valuation level, which is even lower than the -1.0SD to -1.5SD levels recorded during the period (2018-2019) when CPO prices were at RM1,800- 2,000/MT. Additionally, with higher QTD-1QCY20 CPO price (+9% QoQ), we expect to see planters record sequential earnings improvements. For investors seeking exposure to the plantation sector, we recommend taking positions in bashed down names like HSPLANT (OP; TP: RM1.65) and KLK (OP; TP: RM21.30), both of them traded at near -2.0SD valuation level.

The plot thickens. The plantation sector continues to suffer from: (i) adverse COVID-19 impact, and (ii) lower crude oil prices, with the former intensifying after a Restriction of Movement Order from the Malaysian government and Sabah’s palm oil plantation suspension in three districts. Stay NEUTRAL on plantation sector as CPO supply-demand tightness remain relatively intact. Our CY20 CPO price target of RM2,550/MT remains.

COVID-19 proving to be a thorn in the flesh. While the palm oil industry has been exempted from the movement control order by the Malaysian government through, we find the industry besetted by Sabah’s decision to suspend palm operations in three districts namely, Kinabatangan, Lahad Datu, and Tawau. The restriction effectively means a loss of 15 working days for planters in Sabah but a silver lining lies in the fact that the dip in Mar-April production could offset weaker Mar-Apr demand (1-25 Mar exports: -14% MoM) and support CPO prices. Our back of the envelope calculation suggests c.60k/140k MT impact on March/April’s production. Among planters under our coverage we find most affected by the suspension are HSPLANT (OP; TP: RM1.65 - 100% estates in Sabah), IOICORP (OP; TP: RM4.10 – c.60%), and FGV (OP; TP: RM0.950 – c.40%). Having said that, the impact of 15 working days suspension is unlikely to be significant on full-year FFB production as extended harvesting hours could make up for the loss. Additionally, from what we gathered, a 3-week delay in the harvesting of FFB has mild impact on fruit quality and hence, FFB price. Consequently, we are keeping our FFB forecasts unchanged for now but a prolonged suspension or total lockdown of the country would prompt us to revisit our estimates. To put things into perspective, the earlier MCO (loss of 10 working days), if not for the exemption on the palm industry, could have translated into a potential c.600k MT impact on production – reducing ending March inventory closer to the 1m MT mark.

China as knight in shining armor seems far-fetched. YTD (2MCY20) Malaysian palm oil exports to China have fallen 17% and until the virus infection dissipates, palm oil demand from China is likely to remain subdued. At this stage, the possibility of pent-up demand arising from the consecutive low-buying months resulting in backloaded palm oil demand from China once COVID-19 infection dissipates appears faint. This is premised on: (i) China-U.S. soybean purchase pledge, and (ii) high oil and fats ending stocks (as of Feb 2020) in China. To elaborate, for February, China’s oil and fats ending stocks rose (+17.4% MoM) to 2.45m MT (close to the highest level in 2019 of 2.58m MT). This is due to a spike in soybean ending stocks to 1.09m MT (+43% MoM), with it being the preferred vegetable oil during cold weather. Meanwhile, China’s palm oil ending stocks for February stood at 1.05m MT, its highest level from 2018 to YTD-2020, insinuating the unlikelihood of large palm oil imports, at least for the next 1-2 months. Nevertheless, CPO supply-demand tightness remains relatively intact as the expected decline in demand should be offset by an expected dip in production from a lagged dry weather impact, lower fertiliser application and replanting activities during the depressed CPO environment.

Biodiesel mandates uncertainty – crude oil the culprit. The collapse of OPEC+ has resulted in a nosedive of crude oil prices (>-30%) in a single day. Since then, crude oil prices have fallen even more to USD26.98 (as of 20 Mar 2020) and correspondingly palm oil-gasoil (POGO) spread has widened to USD253/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 of a failure to fully implement B30. Based on current brent crude and palm oil prices, the total biodiesel-to-diesel deficit for the full implementation of B30 stands at USD1.35b, after taking into account Indonesia’s biodiesel fund of c.USD1b (refer to Exhibit 1). However, premised on our in-house CY20 crude oil and palm oil assumption of USD40/brl and RM2,550/MT, the deficit would narrow to c.USD540m. This indicates that Indonesia would be able to implement c.24% of its incremental B30 programme, upon full exhaustion of its biodiesel fund (with export levies collected) and also effectively mean an additional CPO supply of c.2.2m MT flooding the market – a drag to CPO prices. Having said that, we do not discount the possibility of their national savings from lower crude oil import and prices channelled to the successful implementation of its B30 programme, given how determined the country seems on driving biodiesel consumption locally.

Valuation de-rating for planters to be expected... Given the increasingly profound risk-off environment and escalating uncertainties surrounding: (i) demand from China due to COVID-19, (ii) implementation of biodiesel mandates owing to lower crude oil prices, and (iii) industry policies due to the shift in Malaysia’s political scene, further valuation de-rating for planters is to be expected. As a result, we adjusted ascribed valuations of our planters (from -0.5SD against mean) to -1.0SD from mean (refer to Exhibit 7). In-line with our valuation de-rating across the board, planters’ TPs have been reduced by 1-30% and we now have 9 OUTPERFORM calls, 3 MARKET PERFORM calls, and 1 UNDERPERFORM call (refer to Exhibit 7 for more details). We see a window of opportunity here for investors to bottom fish given that some planters are currently traded (report cut-off date: 20 Mar 2020) at -2.0SD valuation level, which is even lower than the -1.0SD to -1.5SD levels recorded during the period (2018-2019) when CPO prices were at RM1,800-2,000/MT. Note that YTD20 average CPO price stands at c.RM2,700/MT. Expected improvement in ROEs (see Exhibit 6) for planters also reinforces our case.

... but not all doom and gloom – 1QCY20 earnings (May 2020 reporting season) are expected to improve. After a decent improvement in 4QCY19 earnings, we expect to see planters record sequential earnings improvements in 1QCY20 from higher average CPO prices. Although we are cognisant of the recent fall in CPO prices, it remains a fact that QTD-1QCY20 CPO price (RM2,703/MT) is nonetheless 9% higher when compared to RM2,491/MT for 4QCY19. From our checks, we gathered that most of the planters have done minimal forward selling, allowing them to capitalize on the CPO price rally.

Possibility that drag on production could yet be over. We find it hard to completely rule out the possibility of a re-emergence of the adverse impact on production (from the dry weather, lower fertiliser application and new planting activities) in 2HCY20 as palm tree stress returns after a period of relief. On a separate note, researchers from Justus Liebig University Giessen, the Potsdam Institute for Climate Impact Research, and Bar-Ilan University (whose climate model allegedly predicted the last two El Niño events in 2014 and 2018) have predicted an 80% probability of El Niño returning in late-2020. Although this remains merely a possibility, in the event that the climate model prediction proves true, we could yet again be looking at supply contraction in 2021. In such case, we believe it is not a far cry to construe that CPO prices could react and revisit the highs of RM3,000/MT.

Stay NEUTRAL on the plantation sector on grounds that CPO supply-demand tightness remains relatively intact. Despite the recent fall in CPO price, our CY2020 CPO price forecast of RM2,550/MT remains. Our in-house economist and Oil & Gas analyst forecast crude oil to average USD40/brl in 2020, inferring a colossal recovery (+48%). In the same way CPO price plummeted >RM200/MT (c.10%) in a single day following crude oil’s nosedive (>30%), we anticipate CPO price and other vegetable oils to track crude oil’s expected recovery. Additionally, the soybean oil-palm oil (SBO-CPO) average spread in Mar-20 (MTD) has widened to USD45/MT (vs. a mere USD5/MT in Jan-20), which should lend support to CPO price and affirms us that CPO’s competitive edge against its rival oils is returning. For investors seeking exposure to the plantation sector, we recommend taking positions in bashed down names like HSPLANT (OP; TP: RM1.65) and KLK (OP; TP: RM21.30), both being traded at near -2.0SD valuation level.

Source: Kenanga Research - 2 Apr 2020