The  latest  quarterly  results  for  the  plantation  companies  under  our coverage  universe  were  largely  above  expectations.  Six  out  of  11 reported above estimate results, four booked numbers that were in line and only one company was below forecasts. We expect better quarters ahead on the back of rising CPO prices and lower production costs. We maintain our OVERWEIGHT stance.

Largely  beating  expectations.  The  latest  quarterly  results  for  the plantation  companies  were  largely  above  expectations.  Six  out  of  11 booked  above  estimate  results,  namely:  i)  IJM  Plantations  (IJMP),  ii) Felda  Global  Ventures  (FGV),  iii)  TH  Plantations  (THP),  iv)  Genting Plantations  (GENP),  v)  CB  Industrial  Product  (CBIP),  and  vi)  TSH Resources  (TSH).  Four  companies  had  in  line  results:  i)  Kuala  Lumpur Kepong  (KLK),  ii)  Sime  Darby  (SIME),  iii)  IOI  Corp  (IOIC),  and  iv)  TDM (TDM). Only one, Sarawak Oil Palms (SOP), was below expectations on lower than expected CPO price achieved.  

Dry  weather  affecting  production.  While  fresh  fruit  bunches  (FFB) production  of  most  companies  was  actually  below  expectations,  on extreme  weather  issues,  this  was  offset  by  lower  production  costs  and effective  tax  rates  due  to  deferred  tax  writebacks.  Most  companies acknowledged that dry weather was experienced in their Malaysian and Indonesian  estates  in  4QCY14  and  that  this  weather  is  still  prevalent, resulting in a reduction in their production forecasts/targets for the year. 
However,  as  a  result  of  lower  fertiliser  costs,  most  companies  reported lower CPO production costs during the quarter.

Downstream  operations  reporting  higher  margins.  For  companies with  downstream  operations  like  IOIC,  SIME,  KLK  and  FGV,  most reported  margins  improvement  and  profitability  on  the  back  of  higher sales volumes.  

Overweight maintained. We maintain our OVERWEIGHT stance on the sector.  We believe this is still the early stage of a bull market, as funds have  just  started  to  flow  into  the  palm  oil  sector  and  valuations  remain inexpensive.  Our  Top  Picks  in  Malaysia  include  IOIC,  SOP  and  Jaya Tiasa (JT).

Largely  above  expectations.  The plantation companies’ latest quarterly results were  largely  above  expectations,  with  six  out  of  11  reporting  numbers  that  were better  than  estimated:  i)  IJM  Plantations  (IJMP  MK,  SELL,  FV:  MYR3.05),  ii)  Felda Global Ventures (FGV MK, BUY, FV: MYR5.00), iii) TH Plantations (THP MK, SELL, FV:  MYR1.41),  iv)  Genting  Plantations  (GENP  MK,  NEUTRAL,  FV:  MYR11.20),  v) CB Industrial Product (CBIP MK, BUY, FV: MYR4.30), and vi) TSH Resources (TSH MK, NEUTRAL, FV: MYR2.89). Four companies reported results  that were in line: i) Kuala Lumpur  Kepong  (KLK MK,  NEUTRAL,  FV:  MYR23.95),  ii)  Sime  Darby  (SIME MK, BUY, FV: MYR10.15), iii) IOI Corp (IOIC MK, BUY, FV: MYR5.11), and iv) TDM (TDM MK, NEUTRAL, FV: MYR1.04). Only one player, Sarawak Oil Palms (SOP MK, BUY, FV:  MYR7.04), reported numbers that were below expectations on lower than expected CPO prices. While FFB production of most companies was actually below expectations  due  to  extreme  weather  issues,  this  was  offset  by  lower  production costs and effective tax rates due to deferred tax writebacks.

Dry  weather  impacting  production.  Most  companies  acknowledged  that  their Malaysian and Indonesian estates saw dry weather in 4QCY14 and that this weather is  still  prevalent,  resulting  in  a  reduction  in  their  production  forecasts/targets  for  the year.  According to industry experts at the recent Palm Oil Conference held in Kuala Lumpur, should the dry weather continue for the next two  weeks, production for the second half of the year will also be affected. This could potentially mean CPO prices could  re-rate  upwards  again  in  2HCY14.  In  addition,  should  an  El  Nino  weather phenomenon  occur  in  2HCY14,  as  is  projected  by  some  meteorologists,  this  will further impact production levels and, therefore, keep CPO prices at high levels for the next year or so.

CPO price projection does not take into account any El Nino impact. Currently, our 2014 CPO price forecast is MYR2,700/tonne and MYR2,900/tonne for 2015. Our price projections imply that CPO prices will remain at current levels for the rest of 2Q 2014 on lacklustre production in Indonesia. This is due to the rainfall deficit over the past two  years,  before falling slightly  in  2HCY14,  as  a  result  of  the  peak  production period. We  highlight  that  this  is,  however,  based  on  normal  weather  conditions  and does not take into account any extreme dryness or El Nino impact.

Production costs on the way  down.  On the cost front, most plantation companies reported  lower  CPO  production  costs  during  the  quarter,  due  to  cheaper  fertiliser costs. On a composite basis, fertiliser cost per ha is estimated to have come down by 21.7%  since  Dec  2012.  This  reduction  will  be  reflected  more  obviously  in  the plantation companies’ results from 1QCY14 onwards, as most of them tender for their fertiliser requirements on a half-yearly basis. The dismantling of the potash cartel by Russian  potash  producer  Uralkali  (URKA  RM,  NR)  has  resulted  in  potash  prices declining  by  15.4%  since  mid-2013  while  rock  phosphate  prices  have  declined  by 38.8%.  We  project  production  costs  for  all  the  Malaysian  companies  under  our coverage to decline by 5-10% in 2014.

Downstream  operations  reporting  better  margins.  Companies  with  downstream operations  like  IOIC,  SIME  and  KLK,  mostly  reported  improvements  in  margins  and profitability on the back of higher sales volumes and selling prices. We highlight that companies with further downstream operations like oleochemicals and specialty fats (including IOIC and KLK) generally reported better margins than that of SIME, whose downstream  operations  comprises  mainly  refineries.  Going  forward,  however,  we believe  margins  for  downstream  operations  could  narrow,  as  feedstock  CPO  prices continue  on  its  uptrend,  which  will  lead  to  higher  margins  on  the  upstream  division instead.

Risks. Main risks include: i) a significant change in crude oil price trends that results in  significant  movement  of  CPO  and  other  vegetable  oils  prices,  ii)  weather abnormalities  resulting  in  an  over-  or  under-supply  of  vegetable  oils,  iii)  change  in emphasis  on  implementing  global  biofuel  mandates  and  trans-fat  policies,  iv) significant changes in trade policies of vegetable oil importing or exporting countries, and v) slower-than-expected global economic recovery.

OVERWEIGHT maintained.  We maintain our OVERWEIGHT stance on the sector.  We believe this is still the early stage of a bull market, as funds have just started to flow  into  the  palm  oil  sector  and  valuations  remain  inexpensive.  Our  Top  Picks  in Malaysia include IOIC, SOP and Jaya Tiasa (JT MK, BUY, FV: MYR2.80).

Source: RHB