Plantation sector’s 2QCY22 results were mixed against expectations, disappointing consensus but fairly within our forecasts, though overall lacklustre. More importantly, 1QCY22 and 2QCY22 earnings have captured the recent peaks in palm oil prices, so weaker prospective profits are due and we suspect equity investors also have already imputed lower CPO prices of RM3,500-4,000/MT for FY23. In this regard, much of the 30-40% drop in palm oil prices may have been accounted for already. Thus, ratings of many plantation companies are not very demanding. Coupled this with asset-backed NTA and earnings that are driven by essentials such as food and fuel against a backdrop of uncertain economic outlook ahead, we maintain OVERWEIGHT. Within the sector, we like those with the ability or flexibility to expand upstream such as KLK (OP; TP: RM28.00) and TSH (OP; TP: RM1.80) as well as those able to sustain good dividend yields, the likes of HSPLANT (OP; TP: RM3.00) and BPLANT (OP; TP: RM0.95).

Alacklustre quarter. Unlike 1QCY22, where 20%/40%/40% of results came below/within/above consensus expectations, in 2QCY22, the proportion worsened to 36%/45%/18%. The reverse holds true against our forecasts as the 2QCY22 results came in a tad better at 18%/45%/36% when compared to 20%/60%/20% for 1QCY22.

Among the big three integrated players, only IOI managed to meet market as well as our expectations for 2QCY22 (and 1QCY22 as well). KLK’s results came in line with our forecasts but below the market while SIMEPLNT disappointed both the market and us in 2QCY22. All in all, although 2QCY22 results were good, the results of the big three players were better in 1QCY22 than in 2QCY2. This is also our observation for the sector as a whole.

Headwinds in sight. Recent peak prices for palm oil have been captured in 1QCY22 and 2QCY22. Palm oil prices have since eased by over 30% since early June. Therefore, weaker earnings are only to be expected ahead. We suspect equity investors have already priced in CPO of between RM3,500/MT to RM4,000/MT for FY23F earnings. Our assumptions are unchanged at RM4,500/MT for FY22F and RM4,000/MT for FY23F.

Undemanding ratings. Despite YoY downtrend in earnings on weaker CPO prices, plantation sector ratings may already be bottoming. The sector’s prospective FY23F P/BV of just 1.2x and FY22-23F PERs of 10-11x are approaching replacement level ratings. It is also worth remembering that whilst CPO prices may be off recent peaks, this does not mean the sector is facing a disaster or going to do badly. Even at CPO prices of RM3,500-4,000/MT, operating margins and cash flows are still good as production cost is estimated to hover between RM2,000-2,500/MT moving into CY23.

Defensive qualities. The palm oil sector is the unique source of two essential consumables. About 70% of palm oil is consumed as food while another 20% ends up as biodiesel. As such, besides earnings volatility due to CPO prices, long-term earnings are underpinned by exposure to defensive essential day-to-day consumable products. Also, stock valuation-wise, not only that P/BV is just above NTA but the NTA is also solidly backed by land bank with manageable-to-low gearing levels, some even holding net cash.

OVERWEIGHT. In view of the sector’s defensive qualities and a backdrop of global economic uncertainty, we are maintaining OVERWEIGHT on the sector. Within the sector, we like those offering good sustainable yields such as HSPLANT (OP; TP: RM2.80) and BPLANT (OP; TP: RM0.95). We also like those with the ability or flexibility to expand upstream. Due to dwindling land availability and tightening regulations, upstream expansion has almost stagnated for many players for several years now while downstream expansion is best measured on a case-by-case basis as they can vary from simple refining to complex agribusinesses. We like KLK (OP; TP: RM28.00) and TSH (OP; TP: RM1.80) for their better upstream growth prospects.

Source: Kenanga Research - 14 Sept 2022