Kenanga Research & Investment

Plantation - Selective Gems

Publish date: Tue, 05 Apr 2022, 09:37 AM

After months of poor performance, the plantation sector “caught up” with the broader market in 1Q CY21 amidst unprecedented CPO prices and strong earnings outlook that surpassed expectations. Although we believe ESG investing important, we also believe palm oil is here to stay as it progressively overcome some of its ongoing ESG challenges such as “forced labour” issues. With ESG likely to continue clouding nearer term performances along with easing CPO prices as production improves seasonally hence our NEUTRAL call for the sector. Nevertheless, the sector accounts for for 9.6% by weight in the FBM Shariah Index (and 9.4% in the FBMKLCI), investing in the sector is unavoidable for Shariah funds that are benchmarked against the Shariah Index. Moreover, there are gems in the sector. Our top integrated pick is KLK for strong YoY earnings growth in FY22 while for smaller caps we like HAPLNT for its ability to pay generous dividends and TSH for its longer expansion outlook.

Review of 1Q CY22

The Bursa Plantation Index trailed the broad market for most of 2021 despite strengthening CPO prices due to concerns over ESG. This trend continued until February 2022 when it spiked up to catch up with the KLCI. This is was in part due to (a) record CPO prices (b) straining Russia-Ukraine relationship with eventually erupted into a war on February 24 and (c) overseas funds seeking defensive exposure into beneficiaries of rising food prices which is taking a hold across many parts of the world.

Palm oil outlook for CY22

Oil palm fruit is harvested throughout the year but typically monthly outputs are subject to a yearly cycle. Peak production months often take place during September or October. Thereafter, monthly harvest starts trending down to bottom out around March before production picks once up again MoM. As 2Q typically sees the start of rising palm oil output, CPO prices are expected to start easing on this seasonal improvement in supply coupled with narrowing price discounts or even premium at times when trading against competing soyabean oil (SBO).

However, we believe the price downside for CY22 could be more limited than earlier on account of several factors:

a) Tightness in other edible oils and fats. Whilst palm oil may the most widely used edible oil, it remains only 35% of all edible oils and fats consumed worldwide. As such, poor harvest or supply disruption affecting other oils especially soyabean but also rapeseed or sunflower can support or even lead to higher palm oil prices. Crude oil prices is another factor due to some use of palm, soya and rapeseed oils for biodiesel purposes.

b) The current South American soybean harvest, which is ending soon, has proven more disappointing than expected due to unfavourable weather in Brazil and Argentina. The downward revision meant the present tightness in global oils & fats supply looks set to be extended into the 2H of CY22 even as palm oil output is entering the CY22 production uptrend season.

c) When the Russia - Ukraine tension turned into conflict on 24 Feb, the already tight edible oils and fats supply simply worsened as Europe was hoping to buy Ukrainian sunflower oil to ease pending tightness in rapeseed supply. With mills, shipping and ports in Ukraine having ground to a halt, nearly half the world’s sunflower oil export (6-7m MT) also came to a standstill.

Russian and Ukraine are also major food producers and exporters. Russia is the largest wheat exporter (20%) while Ukraine is the third largest corn exporter (15%) and fifth largest exporter of wheat (10%). Russia is also a major oil & gas exporter as well as fertiliser. Altogether, complicating an already difficult supply-demand balance in the edible oils market as farmers that are able to plant grains or oil crops on their field have options to plant either – essentially competition for land use has just intensified for oil crops moving into late 2022 and 2023.

Environment, Social & Governance

We believe ESG is important when investing. We also believe that palm oil is also here to stay despite the sector’s ESG overhang:

(a) Palm oil is food. It is the most widely used edible oil in the world today with 35% share of the global edible oils and fats market of about 250 m MT a year. 70% of all palm oil is consumed directly or used as ingredients food, from cooking oil to baking shorteners or cocoa butter substitute.

(b) Yielding 3.5 MT of oil per Ha, it is the most productive oil crop in the world. As such it cost competitive and leaves much smaller environmental footprint compared to other oil crops. Yet among better managed planters, 4-5 MT of palm oil per Ha is common. Instead, 6 MT the next target. Considering 5-6MT has already been achieved in selected commercial scale estates, 6 MT is thus a doable milestone.

Certified palm oil already meets very high ESG standards for agriculture products internationally. Therefore, the issue is not about surviving but more about adapting. Encouragingly, many planters have successfully adapted amidst unfair criticisms.

Our thoughts on the sector

Be prepared to see record quarterly earnings for the Jan – Mar CY22 and we expect CPO prices to stay higher and longer than we had anticipated a few months earlier. Therefore, we are in the midst of revising up our CPO price assumption, broadly from RM4,000 to RM4,500 per MT for CY22 and from RM3,500 to RM4,000 per MT for CY23.

However, with CPO prices starting to trade below recent peaks, some caution is understandable. Moreover, with ESG and “forced labour” concerns still fresh in the minds of invicestors, the sector is not likely to trade at premium to the broad KLCI, hence our NEUTRAL recommendation on the sector.

Nevertheless, our integrated pick for the sector is KLK (OP, TP: RM30.00) as we like its recent acquisitions of 95% in IJM Plantations and 60% of PT WItmas Pinang Sejati. The investments were not just ahead of CPO hitting record prices but have enlarged the group’s upstream operations by 30%, so expect strong YoY earnings growth from KLK IN FY22. Among the smaller caps, we like HSPLANT (OP, RM2.65) for its strong and liquid balance sheet which allows it to pay generous dividends moving forward. It is also a Syariah compliant stock. TSH (OP, TO: RM2.08) plans to near double its current planted area over the next 5-10 years thanks to rapid de-gearing and re-capitalising from strong cashflows as well as divestments of assets which are less strategic.

Source: Kenanga Research - 5 Apr 2022

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