Malaysia’s 2QCY20 CPO productionstaged an impressiverecovery(+35% QoQ). Peninsular Malaysia (+40%QoQ)and Sabah (+36% QoQ) anchored the bulk of it, accounting for 87% (or 1.16m MT vs. total 1.33m MT) of the total growth in CPO production. The main beneficiaries would be planters with high concentration of production in Peninsular and Sabah - FGV(95%),HSPLANT(100%), IOICORP(90%)and UMCCA(83%)and based on production data, FGV, IOICORP and UMCCA with CPO production growth of (32-57% QoQ) are the clear winners. This shouldprovide a reprieve to lower CPO price (MPOB 2QCY20: -15% QoQ). Having said that, spot price for CPO is now RM2,835/MT(+40%from lows of RM2,023/MT in May 2020). This could be attributed to concerns of lower production due to recent heavy rainfall, and an expected decline (estimated 15- 20%)in stock levels for July. But, we are unconvinced of current CPO price given that: (i)low inventory levelsaretemporary, (ii) soybean oil-palm oil spread has turned negative RM-12/MT (vs. 2-year average premium of RM+107/MT), (iii) palm oil-gas oil spread has widened to RM+295/MT (vs. 1-year average of RM+111/MT), and (iv) a steepinverted CPO forward curveimplying c.RM313/MT downside (or -11%) in the next 5-6 months. Given reasons above, reward-to-risk favours the latter. Stay NEUTRAL on the plantation sector. Our CY20 CPO price forecast ofRM2,300/MT remainsand we advise cautionin the space. For investors that require exposure in the sector, we recommend HSPLANT (OP; TP: RM1.85), a laggard play – trading at a more palatable -0.75SD valuation level (vs. peers’ mean to +0.5SD).

Stunning 2QCY20 CPO production rebound. Recall that in 2019 (June to early-October), Malaysia experienced a dry weather episode - with consecutive low monthly rainfall (<80mm per month vs. 3-year average of 173mm per month). This had an impact so dire on 4QCY19- 1QCY20 CPO production that CPO prices rallied 67% to reach of RM3,114/MT in January 2020. But after two quarters of consecutive sequential CPO production decline in 4QCY19 (-14% QoQ) and 1QCY20 (-17% QoQ), 2QCY20 production has staged a recovery (+35% QoQ) that is nothing short of impressive (refer to Exhibit 1).

Which region(s) anchored the growth? While CPO production for all the regions in Malaysia was up in 2QCY20 – as trees recovered from prolonged stress from the adverse dry weather impact, Peninsular Malaysia (+40% QoQ) and Sabah (+36% QoQ) anchored the bulk of the growth (refer to Exhibit 2). To put it into perspective, Peninsular and Sabah accounted for 87% (or 1.16m MT vs. total 1.33m MT) of the total growth in CPO production. Meanwhile, June 2020 CPO production at 1.89m MT (+14% MoM; +25% YoY) was also the highest YTD – establishing what we believe to be a “mini-peak”. Our view is in-line with most planters.

Who are the main beneficiaries? Consistent with earlier discussed regions (Peninsular and Sabah) that anchored growth, we believe the planters with high concentration of its production from those regions would be the main beneficiaries. Below (Exhibit 3), we have estimated the production concentration by regions for planters under our universe. The result – FGV, HSPLANT, IOICORP and UMCCA with >80% production concentration in Peninsular and Sabah should benefit the most from 2QCY20 CPO production recovery.

Production data validates the view. Based on our compiled production data (Exhibit 4), FGV, IOICORP and UMCCA with CPO production growth of 32-57% QoQ are the clear winners. We believe the growth in production should provide reprieve to lower CPO price for the quarter (MPOB 2QCY20: -15% QoQ). Naturally, we would expect the trio to fair better when compared to their closest peers given their superior CPO production growth in 2QCY20. Meanwhile, HSPLANT, IJMPLNT, TAANN and TSH also registered pleasant growth of 16-23%.

Spot price for CPO is now RM2,835/MT... Since the lows of RM2,023/MT in May 2020, CPO price has risen (+40%) to a spot price of RM2,835/MT. We believe this could be attributed to: (i) concerns of lower production due to recent heavy rainfall, and (ii) an expected decline (15-20%) in stock levels for July.

… but can CPO price keep on going? We are unconvinced. Our reasons:

1. Low stock levels are temporary. Channel checks with planters reveal that the recent higher rainfall is of no cause for concern. While there are some crop losses due to flooding, the impact is minimal. Inventory levels should pick up as production enters peak season. Most planters are of the view that a second peak would occur in Sep-Oct.

2. Soybean oil-palm oil (SBO-PO) spread has turned negative. With a negative SBO-PO spread of RM-12/MT (vs. 2-year average premium of RM+107/MT), CPO has lost its competitive edge against soybean.

3. Widening palm oil-gas oil spread of RM+295/MT (vs. 1-year average of RM+111/MT) could again, challenge biodiesel demand.

4. CPO futures is in backwardation. A steep inverted CPO forward curve can be observed (Exhibit 6), implying c.RM313/MT downside (or - 11%) in the next 5-6 months.

Valutions re-rating. Following higher CPO prices, we lift planters’ valuations across the board mostly (from -0.5/-1.0SD) to -0.5SD/mean level. Post re-rating, our new calls and TPs are as follow (refer to Exhibit 10 for more details):

OUTPERFORM

HSPLANT (OP ↔; TP: RM1.95 ↑)

MARKET PERFORM

CBIP (MP ↑; TP: RM0.930 ↑), IOICORP (MP ↔; TP: RM4.40 ↑), KLK (MP ↔; TP: RM22.20 ↑), PPB (MP ↔; TP: RM18.50 ↑), SIMEPLT (MP ↔; TP: RM4.90 ↔), SAB (MP ↔; TP: RM3.40 ↔), TAANN (MP ↓;TP: RM2.90 ↔), TSH (MP ↓; TP: RM1.10 ↑), UMCCA (MP ↔; TP: RM4.80 ↔)

UNDERPERFORM

FGV (UP ↓; TP: RM1.15 ↑), GENP (UP ↔; TP: RM8.95 ↑), IJMPLNT (UP ↓; TP: RM1.70 ↑)

Stay NEUTRAL on the plantation sector. Given our reasons listed above, we believe reward-to-risk favours the latter. Our CY20 CPO price forecast of RM2,300/MT remains and we advise caution in the space. For investors that must have exposure in the sector, we recommend HSPLANT (OP; TP: RM1.95), a laggard play – trading at a more palatable -0.75SD valuation level (vs. peers’ mean to +0.5SD).

Source: Kenanga Research - 29 Jul 2020