• Stay BUY, with new MYR2.80 TP from MYR2.85, 9% upside and c.2% FY24F yield. Although we downgrade Sarawak Oil Palms’ (SOP) ESG score to 2.2 (from 2.3), we believe valuation remains inexpensive – trading at 7.8x, at the lower end of its peer range of 6-12x. SOP should benefit from any price upcycle due to the El Nino given its largely pure planter status.

• The European Union (EU) Deforestation Regulation (EUDR) is not unsurmountable. While there are a myriad of problems and issues in complying with the EUDR guidelines based on current regulations, we believe there are also numerous solutions. The Malaysian and Indonesian Governments working together with the EU to find solutions is a step in the right direction – especially if Malaysia and Indonesia are classified as “Low Risk”. Aligning definitions are key to achieving compliance and ensuring everyone is on the same page.

• The EU needs to help, otherwise this problem will be shifted elsewhere. At the end of the day, if the EU fails to help producing countries like Indonesia and Malaysia in complying with the EUDR, it will push producers to export more of their commodities to countries with weaker environmental regulations, thereby shifting the problem to other regions.

• A short term solution would be to ensure that whatever is sold to the EU is produced in segregated mills and refineries and traceable to plantation. This could mean redirecting smallholder crops that are not traceable to other mills to ensure there is no mixing of crops in each plant.

• Uplifting smallholders means uplifting the sector. As smallholders manage 40% of plantation areas in Indonesia and Malaysia, this sector will only progress if they are taken care of and well updated with the changes in laws and regulations. As discussed previously, the main hurdle of achieving traceability lies with obtaining data from third-party suppliers, including smallholders. In order to address this, continuous engagement with the smallholders is essential to educate them on the importance of establishing a sustainable business, while the necessary tools must be given to the smallholders to help them to achieve these goals.

• We believe the sector in general is moving in the right direction in terms of ESG standards, with more disclosure and targets being set. However, we note that there are some outliers which have yet to make any improvements to ESG disclosures as well as ESG targets.

• We downgrade our ESG score to 2.2 for SOP. In 2022, SOP increased GHG emissions and water and energy consumption while its board continues to maintain a composition of <50% Independent Directors.

• Still, we maintain BUY with a lower MYR2.80 TP based on an unchanged 10x FY24F P/E. This includes an ESG discount of 16%. Being a pure planter, we believe SOP will benefit from the El Nino-led upcycle in prices that we are expecting. The company continues to trade at an inexpensive 7.8x 2024F P/E, at the low end of its peer range of 6-12x 2024F. 

Source: RHB Securities Research - 21 Nov 2023