Although Jaya Tiasa stands to benefit from current MYR weakness and the strength in log dynamics, we believe this would be offset by losses at its plantations division due to its high cost structure as well as weakness in plywood demand and pricing. Maintain NEUTRAL as we raise our SOP-based TP slightly to MYR1.25 (from MYR1.20, 1% downside).

Key meeting highlights. On our recent visit to Jaya Tiasa, we came away with six key highlights. These are: i) the logging quota has been reduced by 13.3% from July, ii) log prices are still on the rise, iii) plywood volume is slowing despite the company’s more diversified export base,iv) plywood prices are under pressure, v) the plantation division’s losses are likely to continue in FY16, and vii) capex has been cut down to conserve cash.

Raising earnings forecasts to reflect the change in exchange rate assumptions. Overall, we raise our net profit forecasts by 20-35% for FY16-18. This is after taking into account changes to: i) log production, ii) log exports, iii) plywood prices, and iv) FFB production, as well as after imputing our latest in-house MYR/USD exchange rate assumptions of MYR4.28 (from MYR3.93), MYR4.15 (from MYR4.00) and MYR4.00 (from MYR3.80) for FY16, FY17 and FY18 respectively. We highlight that every MYR0.10/USD change in exchange rate would affect Jaya Tiasa’s earnings by 10-12% pa, while every MYR100/tonne change in CPO prices would affect its earnings by 6-8% pa.

Maintain NEUTRAL. Post earnings revision, our SOP-based TP is tweaked to MYR1.25 (from MYR1.20). We believe that the losses in the plantations division, and the weakness in plywood demand and pricing would somewhat offset the benefits of the exchange rate weakness and the strength in log dynamics. P/E valuations of 13.7x 2016F are also not attractive when compared against its 5-year historical P/E band of 8-12x. There is no change to our NEUTRAL recommendation to the stock.Catalysts to look out for would be a sustainable increase in CPO price trends and a turnaround of its plantations operations, which are running at very high costs currently.

Key meeting highlights. On our recent visit to Jaya Tiasa, we came away with six key highlights. These are: i) the logging quota being reduced by 13.3% from July, ii) log prices are still on the rise, iii) plywood volumes are slowing despite the company’smore diversified export base, iv) plywood prices are under pressure, v) losses in the plantation division are likely to continue in FY16, and vii) capex is being cut down to conserve cash.

Logging quota reduced by 13.3%. During the recent logging quota annual review, Jaya Tiasa’s logging quota was reduced by 13.3% to 936,000 cu m p a (from 1,080,000 cu m). We had warned of this potentially happening in our previous timber sector report dated 26 Jun Reducing Log Production Forecasts, as the Sarawak State Government is revamping its timber licensing policy. This is in light of its renewed commitment to sustainability and conservation. We highlight that none of the other timber companies we cover have had their logging quotas cut during the recent July annual review. Nevertheless, despite this cut, we do not expect Jaya Tiasa to be able to log to quota this year, given that the YTD-August log harvests were at 494,000 cu m only, comprising just 53% of the total revised annual quota. We have, therefore, cut Jaya Tiasa’s log production forecasts to reflect a decline of 6-7% in FY16 (Jun) (from -3-4%), followed by a smaller 3-4% drop in FY17 (from -6-7%). In 2MFY16, log production was down 7.5% YoY, while FY15’s was down 14.3% YoY. Our assumptions do not take into account any extreme weather patterns like El Nino, which would make the transportation of logs difficult due to the low river levels. We also highlight that the Sarawak State Government reduced export log quotas to 40% (from 50%) in July. Although this is being appealed, we have reduced Jaya Tiasa’s log exports to 40% for now (from 45%) to take this change in regulation into account.

Log prices still on the rise. With this supply reduction, we expect log prices to remain firm over the medium term. In 4Q15, Jaya Tiasa’s average log selling price was USD214 per cu m, up 6% QoQ, but down 1% YoY. In MYR terms, however, average log prices rose 7% QoQ in 4Q15 and 13% YoY. This was due to the benefit from the weak MYR/USD exchange rates. Management continues to see stable demand coming from India, which means prices are likely to continue their rising trend. We have projected average log prices to rise 8 -10% in FY16-17, followed by 2% in FY18. As for log production costs, this has remained relatively stable at around MYR380 per cu m.

Plywood volumes slowing… Jaya Tiasa is a bit different from the other timber players under our coverage, in that its main export markets for plywood are more diverse. The company exports its plywood to Taiwan (34%), South Korea (19%), China/Hong Kong (17%), Japan (14%), UK/Europe (8%) and the Middle East (8%), amongst others. This means that it is not as reliant on Japan, unlike its competitors, and gives it more flexibility in terms of re-routing its exports geographically, if need be. Jaya Tiasa is also able to do this because its plywood products are more basic in nature, vis-à-vis its competitors. This is because the company mostly exports general plywood and veneer only. Despite this, the general slowing of economic activities globally has also affected Jaya Tiasa’s plywood sales volumes in 4QFY15, with volumes falling 16% YoY and QoQ.

Management expects plywood sales volumes to remain on a slight downward trend going into FY16, which is in lin with our -5-6% projection. …resulting in weaker USD-based selling prices. This is also expected to translate into lower selling prices going forward. This can be seen by the 13.2% YoY decline in ASP to USD507 per cu m in 4QFY15. Despite this, in MYR terms, plywood selling prices fell by a slight 1.1% YoY only in 4QFY15. This was due to the benefit of the weakening MYR/USD rate. We have cut our USD-based plywood price projections to reflect a 6.7% YoY decline in FY16, followed by a 2% decline in FY17 (from +1% for FY16-17). Jaya Tiasa’s average plywood cost has fallen slightly to MYR1,450 per cu m in FY15 (down 2.7% from MYR1,490 per cu m in FY14).

Losses in the plantation division likely to continue in FY16. Jaya Tiasa’s plantation division has been loss-making for the last three quarters. This was due to weak FFB production and sober CPO prices. In FY15, the company recorded a 3.5% YoY decline in FFB production, contrary to its previously targeted 37% growth. We had explained in our previous report that the shortfall was due to wet weather in Sarawak in 1QFY15, as well as the resignation of one of its main plantation subcontractors who looked after 90% of its plantation estates in Nov 2014. We understand that things have already returned to normal since April/May, as Jaya Tiasa recorded FFB production growth of 65% YoY in 2MFY16. However, this is still short of management’s target of 26% YoY growth for FY16 and our original forecast of +18%, possibly due to the dry weather being seen in Sarawak currently. We have cut our FFB production forecasts for FY15-17 to reflect growth of 9-14% pa (from 10-18% previously). Given the weaker productivity and Jaya Tiasa’s high production costs of MYR2,000 per tonne in FY15 (+12% YoY), we expect the company to continue recording losses in FY16. However, we project this to turn around in FY17, on the back of our higher CPO price assumption of MYR2,550 per tonne (from MYR2,350 per tonne in FY16).

Capex cut down to conserve cash. In light of the current economic climate, Jaya Tiasa is cutting down on its capex requirements to conserve cash. In FY15, the expenditure). In FY16, Jaya Tiasa is planning to cut this down to just MYR88m, wih the bulk of this (92%) being spent on the plantation division for estate upkeep and a new CPO mill. There is no more new planting to be done, as Jaya Tiasa has completed planting on all its planable area of 68,846ha. However, the company is in the midst of setting up one last CPO mill (60 tonnes per hour), which is slated for completion by Mar 2016. We have, therefore, cut our capex assumptions to MYR70m-100m for FY16-18 (from MYR150-170m) to take this into account. Management has also highlighted that there are no M&A plans at the moment, given the lower CPO price environment.

Risks Main risks are: i) a reversal in Japan’s economic recovery that results in an improvement 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 rise in CPO prices.

Forecasts Raising earnings forecasts to reflect the change in exchange rate assumptions.Overall, we raise our net profit forecasts by 20-35% for FY16-18. This is after taking into account the above-mentioned changes to log production, log exports, plywood prices and FFB production. This is also after imputing our latest in-house MYR/USD exchange rate assumptions of MYR4.28 (from MYR3.93) for FY16, MYR4.15 (from MYR4.00) for FY17 and MYR4.00 (from MYR3.80) for FY18. We highlight that every MYR0.10/USD change in exchange rate would affect Jaya Tiasa’s earnings by 10-12% pa, while every MYR100 per tonne change in CPO prices would affect its earnings by 6-8% pa.

Valuation and recommendation Maintain NEUTRAL. Post earnings revision, our SOP-based TP is tweaked to MYR1.25 (from MYR1.20). We believe that the losses in the plantations division, and the weakness in plywood demand and pricing, would somewhat offset the benefit of the exchange rate weakness and the strength in log dynamics. P/E valuations of 13.7x 2016F are also not attractive when compared against its 5-year historical P/E band of 8-12x. There is no change to our NEUTRAL recommendation to the stock. Catalysts to look out for would be a sustainable increasing CPO price trend and a turnaround of its plantations operations, which are running at very high costs currently.