Macquarie Equities Research (MQ Research) resumes coverage on Malaysian plantations with a non-consensus underweight view as it expects crude palm oil (CPO) prices to decline more than consensus, and for structural environmental, social and governance (ESG) headwinds to cap upside due to reliance on foreign labour. In its report dated 15 October, MQ Research says its top pick is Kuala Lumpur Kepong (KLK) with an Outperform rating and lists its order of preference for Malaysian plantation stocks.

Resuming coverage of Malaysian Plantations on a negative note

MQ Research resumes Malaysian Plantation coverage with a non-consensus Underweight (UW) stance. In order of preference, KLK (Outperform (OP), Target Price (TP): RM25.30) > IOI Corporation (IOI) (Neutral (N), TP: RM3.70) > Sime Darby Plantation (SDPL) (Underperform (UP), TP: RM3.00) > Genting Plantation (GenP) (UP, TP: RM5.00). MQ Research prefers planters that are proactive in mergers and acquisitions (M&A), have higher downstream exposure, and good operational metrics (KLK). MQ Research dislikes planters with high upstream exposure and poor operational metrics (GenP). As long as negative ESG issues, which have graduated from mainly ‘E’ to ‘S’ headlines, remain unresolved, MQ Research believes share prices will be capped despite rises in the CPO price. Key downside catalyst for the sector is downturn in CPO prices and the emergence of any further negative ESG headlines.

Downturn in CPO Prices

While the market factors in lower CPO prices, MQ Research’s FY22E/23E CPO price assumptions are 6/10%% below the street, which MQ Research expects to result in further sell-down of the sector (CY21E-23E: RM3,800/RM3,000/RM2,600 per mt). MQ Research’s lower CPO assumptions are premised on (i) better labour supply amongst Malaysia planters; and (ii) slowing soy bean demand from China as hog prices normalise. CPO and share prices have diverged in CY21 year to date (YTD)  as the industry was overshadowed by ESG concerns. With valuations of Malaysian planters still above Indonesian peers and dividends insufficient to justify them as defensive play, MQ Research believes investors will choose Indonesia peers over Malaysia.

Reliance on Foreign Labour Still Risky

Any further emergence of negative labour headlines would deflate the sector even more. In the six months following SDPL’s WRO (Withhold Release Order), its share price declined 20% (vs. KLCI benchmark -8%). Planters are one of the most at-risk industries for labour abuse allegations, given (i) operations expand into rural areas, making them difficult to monitor; (ii) workers are mainly hired from other countries, increasing susceptibility to illegal hiring processes; and (iii) difficulty in automating processes. As these issues are unlikely to be solved soon, there is a likelihood more negative news emerges, which is a key derating catalyst. However, MQ Research still believes palm oil is not without its long-term redeeming qualities.

KLK Top Pick, GenP Least Preferred

After CPO futures touched RM5,000/mt, MQ Research believes it is a good time to sell. Even if the CPO price remains high, MQ Research expects any rallies in share prices to be short-lived. MQ Research’s top pick is integrated player KLK due to its earnings cushion from downstream operations and being an active M&A seeker. MQ Research’s least preferred is GenP, on large upstream earnings exposure and biodiesel-focused downstream operations. Upside risks: Higher dividend payout, La Niña onset, significant brownfield acquisitions.

Source: Macquarie Research - 18 Oct 2021