• Top Picks: IOI Corp (IOI), Sarawak Oil Palms (SOP) and PP London Sumatra Indonesia (LSIP). The plantation industry is at the crossroads – with rising costs, falling yields, little chance for landbank expansion, where can growth come from? As the players are price takers when it comes to upstream operations, they are not able to rely on consistently high CPO prices to bolster earnings. With this, planters are having to do a lot more to boost their bottomlines – is diversification the key? Potential winners in the diversification game would be SD Guthrie (SDG), Kuala Lumpur Kepong (KLK), and IOI. We remain NEUTRAL on the sector.

• Face the hard facts, and adapt. With headwinds like lower yields, older trees, environmental pressures, higher costs, labour issues and lower profitability, the sector has to find ways to circumvent these. CPO prices have risen to highs unseen in the last 10 years, but there is always a risk that extenuating circumstances can push prices down to below breakeven cost levels. We expect long-term CPO prices per tonne to be at the higher end of MYR3,000- 3,500 and above (historical average: MYR1,800-2,000), but prices are likely to stay volatile. As this is not within the planters’ control, they need to focus more on revenue growth, cost control and potential diversification efforts.

• Diversification may be the name of the game, going forward. Some planters have already diversified into other industries like property, fruit farming, glove manufacturing and dairy farming. In recent times, we have seen more ESG-friendly diversification like producing wood and fertiliser, etc and using palm oil waste. However, other than ventures that take advantage of their landbank like land sales and property development, none of these have moved the needle in terms of earnings contributions. With landbank monetisation like data centres (DC) or renewable energy (RE) ventures like solar farms now being a feasible diversification, this may change going forward –if more planters opt to engage. We estimate profitability/ha/year for solar is 26x more than oil palm.

• Other than diversifying earnings, planters will need to increase mechanisation to raise efficiency and reduce their reliance on labour, spend more on R&D to produce better seedlings with higher yields and lower maintenance costs, and put more emphasis on ESG to attain ESG premiums.

• We believe the sector is moving in the right direction in terms of ESG standards, with more disclosure and more targets being set. Our overall average sector ESG score has improved this year to 2.6 (from 2.5).

• Maintain NEUTRAL sector weighting. We believe the bigger boys like SDG, KLK, and IOI will have a better chance of facing current industry headwinds, given their better balance sheets, stronger R&D divisions, and more sizeable landbanks in suitable areas for the development of RE projects, real estate, and land sales. That said, the move to diversify earnings by venturing into RE, or by disposing land or developing landbanks may take some time to gain traction and significantly impact earnings. Our Top Picks remain IOI, SOP, and LSIP, post rolling forward TPs and updating ESG scores.

Source: RHB Securities Research - 12 Aug 2024