Jan-March 2023 FFB output is the best first quarter production since 2019, suggesting 2023 harvest could be on the mend after a subdued two years. Coupled with falling fertiliser prices, unit cost could also be plateauing after having risen aggressively towards the latter half of 2022. Palm oil prices should also average at RM3,800 per MT over 2023 and 2024. All in all, sector earnings should be near or are already bottoming with recovery round the corner for some. Current low PBV ratings indicate that much bad news has been priced in but we suggest staying NEUTRAL due to the lack of compelling upside catalyst. Nonetheless, for investors seeking defensive long-term exposure, we would suggest accumulating KLK among the large integrated players, TSH for long-term growth, HSPLANT for income yield and PPB for its recovering non-plantation businesses.

Best 1Q output since 2019. Early 2023 fruit production reports from plantation groups and the MPOB suggest production is recovering ahead even if the YoY uptick in FFB may be modest. Two-thirds of the companies under our coverage reported higher YoY fruit harvest for the Jan-Mar 2023 quarter (1QCY23) and all, except SIMEPLNT, reported better CPO production as well. The QoQ weakness for both FFB and CPO output is seasonal as production typically peaks in the third quarter to bottom out in the first quarter. Both the MPOB as well as our sector aggregate indicate that 1QCY23 is the best first quarter in terms of production since 2019. 1QCY23 MPOB output of 3.9m MT CPO is also just a shade under Malaysia’s 10- year average of CPO production of 4m MT for the first quarter.

Cost increments may also be stabilising. After labour and depreciation, fertiliser is the third highest cost component in CPO production. Since Jan 2023, prices of fertiliser have fallen sharply. Using the IMF Fertiliser Index as a guide, the index has fallen 29% in just two months (from 268.9 in Jan to 190.6 by March). The March 2023 index of 190.6 is also below the 260-350 range during 2022 and is just 6% above the 2021 full-year average, essentially hovering at levels before the Russia-Ukraine conflict. However, planters often buy fertiliser in advance, so the full benefit of lower fertiliser cost will be felt more in the latter half of this calendar year. Coupled with improving harvest, production costs should be toppish or at least approaching some stability, averaging RM2,000-2,500 per MT of CPO for 2023.

Average CPO price of RM3,800 per MT is expected for 2023. The prospects of improving edible oil supply in 2023 is intact despite poor ongoing soyabean harvest in Argentina which is offsetting an otherwise record harvest in Brazil. However, 2023 demand for edible oil is recovering rather strongly due to: (a) replenishment of inventories by buyers as prices are now more affordable compared to a year ago, (b) China’s recent post-Covid reopening and (c) biodiesel demand, notably from the US, Indonesia and also Brazil. Since both supply and demand are recovering almost in tandem, the overall supply-demand balance is likely to stay fragile hence rangebound CPO prices averaging at RM3,800 per MT for 2023 into 2024.

Impact on earnings and calls. 1QCY23 FFB production variance for individual group is mostly within the 5% range. Notable outliers are HSPLANT, KLK and UMCC. All three did better than 5% YoY rather than worse. However, our CEPS for HSPLANT and KLK have already imputed in 9%/7% YoY improvement respectively in FFB while UMCC’s strong performance was partly reflected in its 3QFY23 results which spanned Nov 2022 to Jan 2023.

Therefore, we are keeping our earning forecasts and recommendations for the sector intact except for two groups:

(a) Instead of higher YoY production, FGV reported a drop of 1% YoY for 1QCY23 FFB output leading us to downgrade FY23F CEPS by 10% but keeping our Market Perform and RM1.40 TP which is based on 1.1x P/NTA less 20% discount over its listing status uncertainty.

(b) CEPS for PPB FY23F is toned down by 11% on weaker-than-expected 1QFY23 results from associate Wilmar. However, we are maintaining our Outperform and TP of RM19.30 as: (a) PPB’s own results is due soon, (b) FY24F earnings are starting to influence valuations and (c) we expect FY24F earnings to recover YoY. Although volatile commodity prices can cause PPB’s earnings to swing QoQ, the group’s exposure to the growing food and consumer sectors in Asia is attractive in the long term. Earnings should also bottom out this year with stronger YoY earnings expected in FY24 and, trading at near BV, a lot of bad news have been reflected in PPB’s share price.

Recommendation: The plantation sector is in transition. Trading at around book, the downturn in the sector has been priced in while some in the sector should start seeing strong earnings come next year. However, there is no strong upside catalyst to prompt an upgrade from our current NEUTRAL view. Instead, we would suggest selective accumulation of groups such as KLK (OP, TP: RM27.00) which is enjoying the benefits of scale and cost savings from having bought over IJM Plantations a year ago, TSH (OP, TP: RM1.35), which is set to expand its planted area by c.30%-50% over time after having de-geared, HSPLNT (OP, TP: RM2.30) with its huge cash surplus offering attractive sustainable dividend yields, and PPB (OP, TP: RM19.30) which should see its non-plantation earnings recovering.

Source: Kenanga Research - 3 May 2023