Malaysian plantation companies have started looking beyond Indonesia for  expansion.  This  could  be  partly  due  to  Indonesia’s  recent  new regulation  that  only allows an unlisted  plantation company or group to own a maximum 100,000ha of plantation acreage. We believe plantation companies will have to either spread their wings geographically to find new land or consider listing in Indonesia.

• Growth constraints.  In recent times, plantation companies in Malaysia have started looking elsewhere besides Indonesia to spread  their  wings. This  could  be  partly  due  to  recent  new  regulations  in  Indonesia stipulating that  a plantation company or group can only own a maximum 100,000ha  in  plantation acreage across Indonesia.  Listed companies in Indonesia are, however, exempted from this rule.  We believe this ruling would mean that plantation companies with close to 100,000ha of land in Indonesia or more will have to either spread their wings geographically to find new land to develop or consider listing their plantation assets  in that country.  
• Four  companies  affected  by  ruling.  Of  the  12  Malaysian  plantation companies we cover, only four  are  likely  to  be affected by this ruling: i) Sime  Darby  (SIME  MK,  BUY,  FV:  MYR10.73),  ii)  Genting  Plantations (GENP  MK,  NEUTRAL,  FV:  MYR9.26),  iii)  KLK  (KLK  MK,  NEUTRAL, FV:  MYR22.40),  and  iv)  TSH  Resources  (TSH  MK,  NEUTRAL,  FV: MYR2.89). These companies have either crossed the 100,000ha mark in Indonesia or are close to  doing so.  They will,  therefore,  need to decide on  their  next  course  of  action  with  regard  to  expanding  their  landbank further.
• NEUTRAL  maintained. We maintain our NEUTRAL call on the sector, with  selective  buying  on  quality  stocks  trading  at  reasonable  multiples. We believe that  average palm oil price will strengthen to MYR2,600 next year from MYR2,400 per tonne this year as demand improves alongside the global economy. Our top sector picks  for Malaysia  are Sime Darby, FGV (FGV MK, FV: MYR4.84) and CB Industrial Product Holding (CBP MK,  FV:  3.64).  However,  any  price  weakness  in  stocks  like  IOI Corporation (IOI MK, NEUTRAL, FV:  MYR6.00) and  TSH  could present some buying opportunities as valuations will be at more palatable levels.  

Growth  constraints.  Plantation  companies  in  Malaysia  have  started  looking elsewhere besides Indonesia to  expand to.  This could be partly due to Indonesia’s recent  regulation  that  essentially  stipulates  that  an  unlisted  plantation  company  or group can only own a maximum of 100,000ha plantation acreage across the country. Listed companies in Indonesia are,  however, exempted from this rule.  This could be due to  the oft-heard complaint that land pricing in Indonesia is no longer reasonable and that the remaining available land in the country is not of good quality. We believe plantation companies with more or close to 100,000ha of land in Indonesia will have to  either  spread  their  wings  geographically  for  new  land  or  consider  listing  their plantation assets there. In this report, we examine which Malaysian company under our coverage will likely have to consider these options.

The stumbling block
Recall  on  30  Sept  that  the  Ministry  of  Agriculture  issued  a  new  regulation  on Plantation  Business  Licence  (IUP),  No.  98/Permentan/OT.140/9/2013,  which replaces the previous Ministry of Regulation No. 26/2007, effective from the date of the regulation.  This ruling states that a  plantation business licence will  be given to a palm  oil  plantation  company  or  a  group  of  palm  oil  plantation  companies  for  a maximum 100,000 ha acreage across Indonesia. Article  17(3),  however,  states  that  State-owned,  local  Government-owned,  cooperations, and public companies (where the majority share is owned by the public) are exempted from this area limitation.  We understand from our conversations with Indonesian plantation operators that this refers to companies listed in Indonesia only.   Another point to note is that this ruling is not applied retrospectively, so companies who already have 100,000ha and above  –  and are not listed in Indonesia  –  should not be affected unless they intend to acquire new landbank.

There  was  another  ruling  that  stated  that  there  is  an  obligation  to  divest  newly constructed  palm  oil  mills  to  farmers'  cooperatives  within  15  years.  However,  we understand this ruling only applies to standalone mill owners (with no land ownership) and not integrated plantation players, like all the companies we cover.

Who is affected by this ruling and what are their options?
Of the 12 Malaysian plantation companies we cover, only four companies would likely be affected by this ruling: i) Sime Darby, ii) Genting Plantations, iii) KLK, and iv) TSH. These companies have either crossed the 100,000ha mark in Indonesia or are close to crossing  it. These companies will,  therefore,  need to decide  on  what is the next course of action when it comes to expanding their landbank further.  Obviously, the options  will  be  to either  spread  their  wings  geographically  or  mull over  listing  their Indonesian  assets  in  Indonesia.  In  Figure  1  below,  we  have  also  included  the uncompleted  acquisition  proposals  of  Kulim  (40,645ha  in  Indonesia)  and  KLK (25,547ha in Liberia).

KLK has chosen to expand outside of Indonesia. Some companies like KLK (with around  145,677ha of landbank in Indonesia) have  chosen their next course of action by going on  a buying spree. KLK’s started with its  Oct 2012  acquisition of 44,342ha of greenfield landbank in Papua New Guinea (priced at approximately  MYR1,200/ha) and its recent (November) proposal to acquire a company with a 25,547ha plantation concession  in  Liberia,  Africa  (priced  at  approximately  MYR4,855/ha).  We  estimate these  acquisitions  will  likely  take  KLK  some  14-15  years  to  digest,  assuming  a planting  rate  of 4,000-5,000ha  per  year.  The company  has  always  been a  pioneer when it comes to entering new plantation areas, being one of the first few Malaysian companies to venture successfully into Indonesia, and we do  not doubt its ability to replicate its success in Papua New Guinea and Liberia, in time.

Sime  Darby  may  look  at  listing  in  Indonesia,  but  no  urgency  to  do  so.  Other companies  like  Sime  Darby  (with  289,422ha  of  landbank  in  Indonesia)  are  already considering/mulling the idea of listing their Indonesian plantations  locally  in order to comply  with  the  ruling,  should  they  need  to  expand  further  in  the  country.  We highlighted this in our report on Sime Darby dated 3 May. However, there may not be any urgency for Sime  Darby  to do this just yet, as it still has its 220,000ha landbank in Liberia  that  it has just begun developing. Up to end -FY13  (FYE June),  the  group has planted up 8,025ha of its Liberian land and intends to plant up at least 5,000ha per year. This means Sime  Darby  will be kept busy with this plantation for the next 20-30 years.

Genting  Plantations  is  still  mulling  its  options,  but  has  time  on  its  hands.
Genting Plantations (with  212,233ha of landbank in Indonesia) is still mulling over its options at this juncture, and is still waiting to see how the new regulation is going to be  enforced.  It  is  unsure  of  the  definition  of  public  company  and  whether  this  will apply to Malaysian public companies. In any case,  the company  still  has more than 150,000ha of unplanted landbank in Indonesia, which will take them another 10 years to digest.

TSH  has not hit the limit yet, but still has a fair amount of  unplanted landbank. TSH  has  not  crossed  the  100,000ha  mark  yet,  but  is  close  to  it  at  93,901ha. However,  this includes  some 64,784ha of unplanted landbank, which will take them another 10+ years to digest.

Risks
The main risks to plantation companies’ earnings include: i) a convincing reversal in crude oil price trend – resulting in a reversal of CPO and other vegetable oils price trends,  ii)  weather  abnormalities  resulting in  an  over -  or  under-supply  of  vegetable oils, iii) changes in the emphasis on implementing global biofuel mandates and trans fat policies, iv) a faster- or slower-than-expected global economic recovery – resulting in  higher-  or  lower-than-expected  demand  for  vegetable  oils,  and  v)  any  further tightening  of  regulations  relating  to  land  expansion/ownership  by  foreigners  in Indonesia.

Valuation and recommendation
NEUTRAL maintained. We maintain our NEUTRAL call on the sector, with selective buying on quality stocks trading at reasonable multiples. We believe average palm oil price will  strengthen to MYR2,600 next year from MYR2,400 per tonne this year, as demand improves alongside the global economy. Our top sector picks  for Malaysia  are Sime Darby,  FGV  and CBP.  However, should there  be  any  price  weakness  for  stocks  like  IOI  Corporatio n  and  TSH,  this  could present some buying opportunities, as valuations will be at more palatable levels.

Source: RHB