We continue to maintain our OVERWEIGHT stance on the timber sector, as  there  has  already  been  some  impact  on  prices  of  certain  Malaysian log  species  as  a  result  of  Myanmar’s log export ban. Meanwhile, the current  dry  weather  and  the  potential  development  of  El  Nino  in  3Q14 could  affect  both  log  and  CPO  supplies  among  the  industry  players, leading to higher prices. Our Top Pick is now Ta Ann.  

Maintain  OVERWEIGHT.  We  continue  to  maintain  our  OVERWEIGHT stance on the timber sector, as there has already been some impact on prices  of  certain  Malaysian  log  species  as  a  result  of  Myanmar’s log export  ban,  which  was  implemented  on  1  April  2014.  The  keruing  log species  (the  closest  substitute  for  Myanmar  logs)  has  seen  a  30% increase in prices so far, due to India’s strong demand. We  expect  the impact  on  prices  of  other  Malaysian  log  species  to  be  felt  from  August onwards, once India’s inventory is depleted.  

Watch  out  for  dry  weather.  The  potential  onset  of  El  Nino  in  3Q14 (based on forecasts of most weather models) could also prove a boon to companies  like  Ta  Ann  (TAH  MK,  BUY,  FV:  MYR5.40)  and  Jaya  Tiasa (JT  MK,  BUY,  FV:  MYR2.95),  as  their  plantation  divisions  currently contribute  30-50%  of  their  total  profits.  Although  palm  oil  prices  have softened of late, we expect prices to strengthen hereon, driven by the dry 
southwest  monsoon,  which  started  in  mid-May  and  has  already  caused an  increase  in  hotspots  in  Sumatra  and  West  Malaysia  from  mid-June. Taking  into  account  our  rising  CPO  price  assumptions  of MYR2,700/tonne for 2014 and MYR2,900/tonne for 2015, as well as their improving  age  profiles,  the  plantation  units  of  these  companies  could contribute 50-70% of total profits by 2015.  

Switching  our  Top  Pick  to  Ta  Ann.  We  maintain  our  target  CY15F P/Es  of  10.0-12.0x  for  the  timber  divisions  and  16.0x  for  the  plantation divisions for the three stocks under our coverage – Jaya Tiasa, Ta Ann 
and  WTK  (WTKH  MK,  BUY,  FV:  MYR1.80).  We  keep  our  BUYs  on  all three  stocks,  switching  our  Top  Pick  from  Jaya  Tiasa  to  Ta  Ann.  We believe Ta Ann offers the biggest upside currently, as valuations are still 
relatively  inexpensive,  while  earnings  growth  is  at  an  impressive  3-year CAGR  of  34%,  mainly  coming  from  increasing  maturity  of  its  plantation landbank.

Maintain OVERWEIGHT. We continue to maintain our OVERWEIGHT stance on the timber sector, as there has already been some impact on prices of certain Malaysian log species as a result of Myanmar’s log export ban.  Meanwhile,  the  current  dry weather and the potential development of El Nino in 3Q14 could also affect both log and CPO supplies among the industry players, leading to higher prices. Positive  impact  from  Myanmar’s log export ban.  Myanmar’s log export ban was strictly implemented from 1 April 2014. However, we understand that prior to the ban, India, the largest importer of Myanmar’s tropical logs, had stocked up. Therefore, it has  enough  inventory  to  last  until  July.  Despite  this,  certain  Malaysian  log  species like  keruing  (the  closest  substitute  for  Myanmar  logs)  have  seen  growing  demand from  India,  resulting  in  prices  rising  by  30%  to  USD350.00/cu  m  currently  from USD270.00/cu m as at end-2013. Prices of other Malaysian tropical log species like meranti,  which  is  used  as  our  benchmark,  have  not  risen  by  as  much  over  the  last few months, up by an average 3-5% since end-2013. However, once the inventory in 
India runs down by July, we believe the impact on prices of other log species could start coming through more significantly. In addition, most timber companies are of the view  that  India's  opposition  party,  which  was  recently  elected  as  the  new Government, is expected to be more pro-business. Of special interest is whether the new  administration  will  eliminate  the  controversial  2012  legislation  that  allowed  for retroactive corporate taxes.

Dry  weather could  lead  to weak  log  supply.  The  weather  in  Sarawak  is currently fine and dry, and is expected to remain this way through September. This means that log transportation via barges on the rivers will likely get more difficult, as river levels are  not  high  enough.  As  such,  log  producers  may  have  to:  i)  harvest  fewer  logs,  ii) 
resort  to  transportation  by  land  –  which  is  more  costly  (estimated  at  about USD20.00/cu m more), or iii) find other rivers that are not as badly affected by the dry weather to transport their logs. This may require new infrastructure to be built. Should an El Nino weather phenomenon occur, this could lead to a more severe log supply shortfall and, subsequently, impact log prices. Hence, we believe our forecasted price increases of 6-8% per annum for CY14 and CY15 are achievable.  

Flattish  plywood  prices  still...  Demand  from  Japan  continues  to  remain  rather sombre in the first few months of 2014. Concrete panel prices are USD510.00-520.00 per cu m, down slightly by 2-3% from end-2013 levels. Meanwhile, floor base prices reached  USD690.00-700.00  per  cu  m,  up  by  about  2-3%  from  end-2013  levels. Housing  starts  in  Japan  have  also  stalled  somewhat,  with  YTD-April  growth  of  just 1.6%, vs 11% in 2013. Although plywood import volume has risen by a higher 11% y-o-y  during  the  same  period,  the  bulk  of  this  increase  may  have  come  from  sources other than South-East Asia, as the region’s plywood imports only grew by 0.2% in the same period.

…despite  rising  Japanese  house  prices.  Nevertheless,  Japan  Lumber  reported that the average price of an existing detached house in Japan has increased by 2.4% since the beginning of this year. Builders are also finding that, while housing demand has  slowed  after  the  sales  tax  increase,  it  is  still  at  its  strongest  in  more  than  five years,  which  could  be  a  result  of  the  Government’s  reflationary  policies.  Japan Lumber expects house prices to continue rising in 2014, given that the Government is expected to inject an additional stimulus package in 2HCY14. Therefore, we prefer to maintain our plywood price assumptions of +2-3% y-o-y for CY14-15 for now. Demand  from  South  Korea  may  slow.  We  highlight  that  timber  companies  that export plywood to South Korea could see a slowdown going forward, as the country has decided to reintroduce anti-dumping duties of 3.08-38.1% on Malaysian plywood for  the  next  three  years.  The  previous  anti-dumping  duty  expired  at  end-Jan  2014. With  this  decision,  anti-dumping  duties  could  be  re-imposed  as  early  as  end-July 2014. Currently, of the three timber companies we cover, only Jaya Tiasa exports a significant  amount  to  South  Korea.  Both  Ta  Ann  and  WTK  Holdings  export  their plywood  mainly  to  Japan.  When  the  duty  was  first  implemented  in  Feb  2011,  Jaya Tiasa’s plywood was taxed at 6.43%, and its exports to South Korea fell to as low as 5% of plywood sales from 43% in the previous quarter. This picked up to 10-20% in the  subsequent  quarters. We highlight  that  Jaya  Tiasa  has managed  to  increase its plywood  volume to  other markets  like  Taiwan,  the  Middle East  and  the  US to  offset the lower volume to South Korea when the anti-dumping duty was still effective.   

El  Nino  could  also  affect  CPO  prices.  The  potential  onset  of  El  Nino  in  3Q14 (based on forecasts of most weather models) could also prove a boon to companies like Ta Ann and Jaya Tiasa, as their plantation divisions currently contribute 30-50% of their total profits. Although palm oil prices have softened of late, we expect prices to  strengthen  hereon,  driven  by  the  dry  southwest  monsoon,  which  started  in  mid-May and has already caused an increase in hotspots in Sumatra and West Malaysia from  mid-June.  Taking  into  account  our  rising  CPO  price  assumptions  of 
MYR2,700/tonne for 2014 and MYR2,900/tonne for 2015, as well as their improving age profiles, the plantation units of these companies could contribute 50-70% of total profits by 2015.

Maintain  OVERWEIGHT.  In  view  of  stronger  plantations  earnings  and  a  stable-to-improving  outlook  for  the  timber  industry,  we  maintain  our  OVERWEIGHT  rating  on the  sector.  We  also  maintain  our  target  CY15F  P/Es  of  10.0-12.0x  for  the  timber divisions  and  16.0x  for  the  plantation  divisions.  We  keep  our  BUYs  on  all  three stocks, with our Top Pick being Ta Ann. We believe Ta Ann offers the biggest upside currently, as valuations are still relatively inexpensive, while earnings growth is at an impressive  3-year  CAGR  of  34%,  mainly  coming  from  increasing  maturity  of  its plantation landbank.

Source: RHB