Despite the recent political tensions between India and Malaysia, Macquarie Equities Research (MQ Research) shared its positive outlook on the crude palm oil (CPO) markets, with an expectation that the CPO price will rebound to RM2,500/mt. In yesterday’s report (28 Oct), MQ Research discussed the reasons behind it and also initiated coverage on plantation counters. Read on for more.

Initiate coverage on Malaysia Plantations sector on a positive note

Going into CY20E MQ Research expects the CPO price to rebound to RM2,500/mt, and MQ Research believes interest in upstream Malaysian Plantations names will pick up, as they have the highest earnings leverage to CPO prices. The tightening in the vegetable oil complex in CY20E, the first since 2016, has underscored MQ Research’s conviction of a more supportive CPO fundamentals in CY20E. The CPO price hit a 5-year low in 2Q19, taking it close to the cost of production of the less-efficient players.

However, MQ Research believes the CY19E earnings impact is already priced in – the Bursa Plantations Index has dropped by 11% from its CY19 high. Against this backdrop, MQ Research initiates coverage on Sime Darby Plantations and Kuala Lumpur Kepong. MQ Research’s top picks in ASEAN Plantations are First Resources (FR SP, S$1.56, Outperform, TP: S$1.90), London Sumatra (LSIP IJ, Rp1,335, Outperform, TP: Rp1,620) and Sime Darby Plantation (SDPL MK, RM4.72, Outperform, TP: RM5.30).

CPO price rebound – YTD inventory contraction not a red herring

MQ Research’s CPO price/mt targets are CY20E: RM2,500 and >CY21: RM2,734. Throughout CY19E, MQ Research saw inventory contracting from 3.0mn mt (Jan) to 2.4mn mt (Sept) and cumulative 9MCY19 exports growing by 15.3% YoY. MQ Research thinks the trajectory will continue well into CY20E, underpinned by the tightening in the vegetable oil complex. Despite the upbeat outlook in CY20E, MQ Research believes price volatility will continue from now till 2Q20 before seeing a meaningful rally. Post first-half harvesting, coupled with the festive season (Ramadhan starting end-April 2020), could yield lower production and thus drive a further drop in inventory, MQ Research believes.

Initiate on Sime Plant and KLK; MQ Research prefers Sime Plant

• Sime Plant (OP; TP RM5.30) – MQ Research expects operational stats to improve, and this will pare down its costs and improve profitability. MQ Research estimates earnings per share (EPS) to grow at a 26% compound annual growth rate (CAGR) in FY19-22E. Operating at a higher cost of production to peers, Sime Plant has a high sensitivity with a 25% impact to EPS for every RM100 movement in the CPO price – giving it the highest earnings leverage during a rising CPO price trajectory.

• KLK (N; TP RM23.00) – MQ Research believes KLK remains the safest play for the Malaysia Plantation sector but not so during a rising CPO price trajectory – sensitivity of 10% for every RM100 movement in the CPO price. MQ Research factored in a CPO price recovery, better operational stats and earnings growth of a 10% CAGR in FY19-22E; all told, MQ Research believes the upside is priced in.

Headline risk – India banning Malaysian CPO is MQ Research’s main concern

MQ Research believes the main downside risk is that India begins to gradually stop CPO imports from Malaysia due to the current political tensions. India is the biggest importer of Malaysian CPO, with a total share of 28% of YTD Malaysian CPO exports. Losing India as the key customer could severely hurt the CPO price.

12-month Target Price Methodology

• KLK MK: RM23.00 based on a discounted cash flow (DCF) methodology
• SDPL MK: RM5.30 based on EPS methodology

Source: Macquarie Research - 29 Oct 2019