The investment case for the plantation sector is no longer earnings recovery but earning resilience especially when concerns over high inflation and weakening economy are clouding the market. After outpacing the broader market in 1Q 2022, the KL Plantation Index consolidated for much of 2Q 2022 before dipping this month on broad equity weakness led by the US. CPO prices then fell as Indonesia reopens for exports coupled with seasonally rising palm oil output as well as pending US soyabean harvest in 3Q/4Q. Peak palm oil prices may be behind us but plantation earnings look set to stay healthy on resilient demand for palm oil. Robust margins are also expected on firm price outlook despite rising cost. The sector’s defensive asset-rich NTA is another attraction and valuations are not excessive either, trading at or even below the broad market ratings with some offering good yields. For investors benchmarked against the Shariah Index, the sector is also unavoidable as the plantation sector accounts for 9.6% by weight in the FBM Shariah Index (and 9.4% in the FBMKLCI). Upgrade from NEUTRAL to OVERWEIGHT.
Peering into 2Q 2022 earnings seasons, another good set of plantation earnings can be expected before earnings moderate after 2H on softer CPO price outlook. Nevertheless, we expect CPO prices to stay firm, averaging at RM4,500 per MT in 2022 and RM4,000 per MT in 2023 against production cost of between RM2,000 to 2,500 per MT; hence, margins are attractive. Our expectation of firm CPO prices for 2022 and 2023 hinges on the following:
(a) Supply is likely to be stay fragile until 2023. Any seasonal uptick in 2H of 2022 will provide a welcome relief but unlikely to reverse the overall tightness. An above average season in 2023 could just about reverse the tightness.
(b) Sticky demand is also likely. Edible oils and fats are part of our daily diet. As such, cutting consumption can be done, especially temporarily but deeper more prolonged cuts are less easy.
(c) Elevated fossil fuel prices are supportive of demand for biofuel; thus, demand for edible oils.
Responsible agriculture is important and palm oil - the most widely used edible oil – has drawn more than its rightful share of media and NGO’s attention. However, the Russia–Ukraine conflict highlights just how ill prepared the world is in facing a supply shock to the global food chain. This may reset towards a more rounded perspective on food security and ESG going forward. Importantly, the palm oil industry has progressively addressed various ESG issues. Certified palm oil supply is on the rise and they meet some of the highest agriculture standards worldwide.
Importantly, recent market sell-down has rendered the sector even more attractive considering the sector’s defensive business and solid asset base. We are upgrading the sector from NEUTRAL to OUTPERFORM. Our top integrated pick is KLK (OP, TP: RM30.00) which offers strong YoY earnings growth in FY22, a beneficiary of firm prices of edible oils and biofuels with strong balance sheet and track record. We also like mid-cap such as BPLANT (OP, TP RM1.00) and HAPLNT (OP, TP RM3.30) for generous dividends and TSH (OP, TP RM1.90) for long-term growth as it seeks to expands its planted area from under 40k Ha to 60-65K Ha over the next 6-8 years.
Source: Kenanga Research - 24 Jun 2022