1QFY23 results missed expectations as strong average CPO price realised of RM4,496/MT is unlikely to be repeated during the remaining quarters in FY23. Its downstream manufacturing performed well which compensated for an otherwise soft upstream. We cut our FY23-24F core EPS by 10-15%, trim our TP by 2% to RM4.00 (from RM4.10) but maintain our MARKET PERFORM call.

1QFY23 core net profit came in at 31% and 41% of our full-year forecast and the full-year consensus estimate, respectively. However, we consider the results below expectations as strong average CPO price realised of RM4,496/MT is unlikely to be repeated during the remaining quarters in FY23.

Steady 1QFY23. Upstream plantation operating profit of RM295m (-3% QoQ, +8% YoY) was unremarkable despite achieving stronger-than expected CPO price. FFB output of 666K MT was mix, up 9% QoQ due to seasonally peak harvesting in 1QFY23 but 11% weaker YoY due to labour constrains and rainy season. Lower fruit output coupled with higher fertiliser cost also nudged up production cost. Fortunately, the poor performance of the upstream weakness was offset by strong downstream, resource-based manufacturing operating profit of RM307m (+88% QoQ, +115% YoY), thanks largely to good oleochemicals margins. Associate contribution also grew YoY to RM80m but weaker QoQ largely because 32%-owned upstream associate, Bumitama Agri, did exceptionally well in the preceding quarter (IOI’s 4QFY21) with net profit of IDR1,306b (+50% QoQ, +312% YoY) on strong CPO prices and FFB output versus IDR655bn (+11% YoY) for the recent July-Sept 2022 quarter (IOI’s 1QFY23). End Sept 2022 net gearing is a manageable 21% as net debt declined to RM2,225m (-10% QoQ, -16% YoY).

Softer quarterly earnings ahead. Palm oil prices have corrected sharply since 2QCY22 on recovering edible oil supply. However, CY23 supply-demand balance still looks fragile as demand is also expected to rebound. Amidst the prospects of global economic headwinds in CY23, slower edible oil consumption cannot be outrightly dismissed. However, as much as 70% of edible oils end up in the global food chain which is why past demand stayed quite resilient during previous economic slowdowns. Moreover, post Covid recovery demand was muted in 1HCY22 as record high prices kept buyers at bay to just essential quantity. China, a big market, has also not reverted to a new post Covid normal though recent relaxations suggest the zero-Covid policy may be lifted in 1H CY23 which we suspect after the winter flu season. Demand for biofuels has also been strong thanks to elevated fossil fuel prices. US biofuel consumption has risen while Indonesia and Brazil are considering raising their biofuel utilisation in CY23. Altogether, we expect CPO prices to stay relatively firm and maintaining IOI’s FY23 CPO price at RM4,000 but adjusting down FY24 assumption from RM3,800/MT to consolidate at RM3,500/MT.

Resource-based earnings are more susceptible to slower demand arising from the prospects of global economic headwinds. The group’s European downstream units are also enduring rising energy costs and may even encounter supply disruptions. Therefore, despite enjoying good margins, better pricing power (more specialty than commoditised products) with lower input palm oil prices, we expect weaker QoQ contributions ahead.

Forecasts. Downgrade FY23-24F CEPS by 10-15% to 24.8-19.6 sen.

Maintain MARKET PERFORM but on slightly lower TP of RM4.00 (from RM4.10) on FY23F CEPS at PER of 15x based on integrated peers’ rating plus a 5% ESG premium. IOI’s strong downstream operations and Europe current energy woes may benefit the group over time even if there is some temporary setback to its operations there. Hence, some downstream expansions outside Europe or M&A cannot be ruled out. IOI also offers defensive qualities such as strong land backed NTA, manageable if not comfortable gearing and a good ESG rating of 4-star. The group’s upcoming wood palm project could also be a game changer as the plantation industry heads towards net zero.

Risks to our recommendation include: (i) weather impact on edible oil supply, (ii) unfavourable commodity prices fluctuations, and (iii) production cost inflation.

Source: Kenanga Research - 29 Nov 2022