Although  WTK continues benefiting  from higher  India  log demand  and rising  prices,  the  plywood  division’s  outlook  is  not  as rosy  –  sombre Japan  demand and flattish prices.  Meanwhile,  the plantation division’s contributions  remain  insignificant.  We  trim  our  forecasts  slightly  and lower our FV  to MYR1.32  (from MYR1.40), based on  an unchanged 10x CY15  target  P/E.  Our  new  FV  suggests  a  0.75%  downside.   Maintain NEUTRAL.

Key  highlights  from  our  recent  visit:  i)  Higher-than-expected  log production  in  8MFY14  (+11.2%),  ii)  log  prices  continuing  to  rise;  iii) sombre  demand  for  plywood  in  Japan;  iv)  plywood  prices  holding  up well, and v) slow new planting for palm oil land.

Some  good  news,  some  not-so-good  news.  The  weather  has  been kinder  on  log  producers  like  WTK  after  1Q14,  as  its  log  production picked up considerably by 11.2% in 8MFY14. This additional supply has been  soaked  up mostly  by  India,  which  took  up  64%  of  Sarawak’s log exports  in  1H14  (from  61%  in  2013),  despite  higher  volumes  of  logs being exported during the same period (+8.2%  y-o-y). This has resulted in  a  continued  increase  in  average  export  log  prices,  which  were up 11.5%  y-o-y  in  1HCY14.  Given  the  robust  demand  from  India,  we  are still positive on WTK’s log division prospects. However, not all is rosy on the  plywood  division  front,  as  sales  volumes  to  Japan  are  weakening post sales-tax hike,  although selling prices have remained stable.  As for WTK’s  plantation  division,  new  planting  has  slowed  somewhat,  which implie s that significant contributions from this division could come in later than FY17. 

Trimming  earnings  forecasts.  We tweak our earnings  forecasts lowerby  2.9%  for  FY14  and  by 3.8%  for  FY15,  after  adjusting  for  lower plywood sales volumes, which more than offset our adjustment for higher log production. 

Maintain  NEUTRAL.  We  maintain  our  NEUTRAL  recommendation  on the  stock,  with  a  lower  FV  of  MYR1.32  (from  MYR1.40),  based  on unchanged  target  P/E  of  10x  CY15.  Although  prospects  for  the  log division  are  still  positive,  this  is  offset  by  weaker  fundamentals  at  the plywood  division,  while  earnings  contribution  from  the  plantations division are still insignificant (at <10% of group earnings).

Key  highlights  from  our  recent  visit:  i)  Higher-than-expected  log  production  in 8MFY14 (+11.2%); ii) log prices  continuing to  rise; iii)  sombre demand for plywood in Japan; iv) plywood prices holding up well; and v) slow new planting for palm oil land.

Higher-than-expected log production. In 8MFY14, WTK produced 319,410 cu m of logs (+11.2% y-o-y), which is higher than our projected +1% growth in log production for FY14. Management is projecting to log about 450,000-480,000 cu m of logs this FY14, which translates into a y-o-y growth of 5%-12%. This is  on the back of muchneeded rain  coming through after 1Q14, which led to easier log transportation on the rivers, as well as increasing orders from customers, as WTK tends to harvest its logs based on the volume of orders coming through. We are therefore adjusting our log production forecasts accordingly for FY14 and FY15 to reflect an 8% and 0% growth, respectively. We highlight that it should not be a problem for WTK to further increase log production should the need arise, as there is still some way to go before it hits it s log harvest annual quota of 600,000 cu m per year.

Rising log prices.  WTK recorded an average  export  log price of USD248/cu m in 2QFY14,  bringing  its  1HFY14  average  export  log  price  to  c.USD236/cu  m.  This implies  an  increase  of  11.5%  y-o-y,  and  10%  q-o-q.  Going  into  3QFY14, management continues to see an increasing price trend  for logs, on the back of stillstrong demand from India, which  takes up 75-80% of WTK’s log exports.  India took up  64%  of  Sarawak’s  log  exports  in  1H14  (from  61%  in  2013),  despite  higher volumes of logs being exported during the same period (+8.2% y-o-y). Based on this trend,  we  expect  demand  to  remain  robust  and  believe  our  export  log  price assumptions  of  USD230/cu  m  for  FY14  and  USD260/cu  m  for  FY15  remain achievable.

Sombre demand for plywood in Japan...  On the plywood front, things are not as rosy.  In  1H14,  WTK’s  plywood  sales  volumes  fell  by  9.4%  y-o-y.  The  decline  was attributed to a slowdown in demand from Japan in 2Q14, particularly after the sales tax  hike  took  place  on  1  April.  We  estimate  WTK’s  capacity  utilisation,  based  on annualised  sales  volumes,  to  be  about  60%-65%.  Management  expects  capacity utilisation to stay at these levels for the rest of the year, which are  slightly below our projected 70%-75%. We therefore  adjust our sales volume forecasts down slightly to reflect  capacity  utilisation  of  60%-65%  (from  70%-75%)  for  FY14-15.  However,  we highlight that with the likelihood of another consumption tax hike in Japan in Oct 2015 (to 10% from 8%), there could be another round of pre-tax hike buying, which would help boost plywood demand in the first half of 2015.      

… but plywood prices holding up well.  Despite the decline in volumes,  average plywood  selling  prices  held  up  well,  rising  by  a  slight  2.4%  y-o-y  in  1HFY14  to  c. USD600/cu m.  Management expects plywood prices to remain flattish  for the rest of the  year,  given  the  subdued  demand from  Japan.  As the  YTD  plywood  prices  are slightly  lower  than  our  projected  USD620/cu  m  for  FY14,  we  are  reducing  our assumptions  slightly  to  USD606/cu  m  for  FY14  and  USD620/cu  m  for  FY15  (from USD630). 

Slow  new  planting  at  plantations  division.  WTK’s  plantation  division  is  facing some  snags  with  new  planting,  having  only  planted  up  approximately  500ha  in 1HFY14, as opposed to its original new planting target of 1,500-2,000ha per annum.

Total planted area as at end-1HFY14 is now 11,800ha. Management attributed this to som native  issues being faced at the plantations.  We adjust our forecasts to take into  account  1,000ha  (from  2,000ha)  of  new  planting  in  FY14  and  maintain  our projected 2,000ha for FY15.

Risks
Main risks. These include: i) a reversal in Japan’s economic recovery, resulting in a decline  in  the  country’s  housing  starts, ii) log  production  recovering  in  a  significant manner  from  Malaysia,  or  if  Indonesia  lifts  its  ban  on  log  exports,  iii)  a  significant change  in  direction  of  the  MYR/USD  exchange  rate,  iv)  the  imposition  of  import duties  on  large  export  markets  like  India  and  Japan,  and  v)  a  change  in supply/demand dynamics leading to a sharp fall in CPO prices.

Forecasts
Trimming  earnings  forecasts.  We tweak our earnings  forecasts lower  by  2.9% for FY14 and 3.8% for FY15 to account for the abovementioned changes.

Valuation and recommendation
Maintain NEUTRAL.  We maintain our NEUTRAL recommendation on the stock, with a lower FV of MYR1.32  (from MYR1.40).  Although prospects for the log division are still  positive,  this  is  offset  by  weaker  fundamentals  at  the  plywood  division,  while earnings  contribution from  the  plantations division  are  still insignificant  (at  <10%  of group earnings).

Source: RHB