Plantation  share  prices  have  been  rallying  of  late,  possibly  due  to  a combination of factors. However,  CPO prices have not sustained  above MYR2,600/tonne, which we believe is needed to hold share prices up for a sustained period.  While plantation share prices may remain buoyant for the next few months,  they  may begin to adjust should earnings start to disappoint and valuations remain sky high.

• Plantation shares rallying...  Plantation share prices have been rallying in the last  two  days, possibly due to: i) potentially  weaker-than-expected CPO production in the upcoming  months leading to higher CPO prices,ii)  a  potential  larger-than-expected  impact  of  the  Indonesian  biodiesel mandate  on  stock  levels  in  Indonesia,  iii)  the  laggard  nature  of  the plantation  index  (KLPLN)  in YTD up to  the  end of last week of  5.9% vs KLCI  7.9%, and iv) Dorab Mistry’s change in CPO price view to a more bullish one (released on 14 Nov).
• …possibly due to combination of factors.  We  believe a combination of factors has led to the two-day +3.4% rise in  the KLPLN. While we are seeing  slightly  lower-than-expected  production  numbers  from  some Indonesian  players,  which  could  help  provide  some  support  to  CPO prices,  the  lower  output  has  not  been  enough  to  sustain  CPO  prices above  MYR2,600/tonne,  which  we  believe  is  the  key  to  holding  share prices  up  for  a  sustained  period.  We  believe  the  Indonesian  biodiesel story  would  mainly  serve  to  provide  a  floor  for  CPO  prices,  but  not necessarily  boost  demand  exponentially.  Our  forecasts  have  already priced  in  average  prices  of  MYR2,600/tonne  for  CY2014.  As  such,  we believe  that  while  plantation  share  prices  may  remain  buoyant  for  the next few months (likely up to 1Q2014),  they may adjust should  earnings start to disappoint and valuations remain at sky-high levels.
• Peak valuation targets throw  out some stocks to trade on. We did a sensitivity analysis on our fair values, applying a higher P/E range of 18-20x CY14 (from 16-18x currently) on our Malaysian plantation stocks to attain  a  “peak”  fair  value  (see  Figure  1).  Based  on  this  analysis,  we believe there is  >10%  upside to be gained from stocks like  FGV (FGV MK, BUY, FV: MYR4.84), Sime Darby (SIME MK, BUY, FV: MYR10.73),IOIC (IOI MK, NEUTRAL, FV: MYR6.00)  and TSH (TSH MK, NEUTRAL, FV: MYR2.89),  and about 5% upside to be gained from stocks like SOP (SOP  MK,  BUY,  FV:  MYR6.05).  Kulim  (KUL  MK,  NEUTRAL,  FV: MYR3.53) and TDM (TDM MK, NEUTRAL, FV: MYR0.97).    We are not revising  our  fair  values  at  this  point,  preferring  to  re -evaluate  them  on their  results  release.  Maintain  our  medium-term  NEUTRAL  outlook  on the sector.

Source: RHB