Plantation - UOB Kay Hian 2016-04-20: Not Too Late Yet

Plantation Sector FIRST RESOURCES LIMITED EB5.SI BUMITAMA AGRI LTD P8Z.SI WILMAR INTERNATIONAL LIMITED F34.SI GOLDEN AGRI-RESOURCES LTD E5H.SI INDOFOOD AGRI RESOURCES LTD 5JS.SI

Plantation – Regional Not Too Late Yet

North American clients are now more receptive to the plantation sector as a palm oil supply deficit is expected over the next two years. They are also less bearish on the soybean and crude oil markets.
Wilmar was the most discussed stock idea. It is a clear beneficiary of the recent strong recovery in sugar prices and is enjoying a positive earnings boost from better palm prices and steady consumer pack margins.

Maintain OVERWEIGHT.

WHAT’S NEW

 Better traction from North American clients.

During our recent marketing trip to North America, we found that clients are now more receptive to our plantation sector OVERWEIGHT call than they were 6-12 months ago.
Key factors behind the change in their sector views are as follows:

 Palm oil supply deficit.

There is a high possibility of two consecutive years of a palm oil supply deficit, given that nothing can be done to improve production yields after the damage caused by the severe dryness in 2015. This is the main factor that drew clients’ attention to the sector.
The deficit situation could worsen if soybean production from the upcoming soybean planting disappoints.

 Neutral to positive outlook for soybean market.

We found that portfolio managers are now less bearish on the soybean market as they expect much slower supply growth and steady demand from China (62% of global soybean imports). The current build-up in inventories was due to a huge supply.
Meanwhile, demand remains relatively stable.

 Stocks discussed the most: Wilmar, FR and GGR.

Most fund managers require companies to have a market capitalisation of at least US$2b and daily turnover of at least US$1m.
Stock ideas that met these criteria were Wilmar, First Resources (FR) and Golden Agri Resources (GGR). Among the three, Wilmar is a clear beneficiary of the price recovery in soft commodities, including sugar which saw a strong price surge supported by expectations of a supply deficit in the market.

ACTION

 Maintain OVERWEIGHT.

The current weakness in CPO prices provides an opportunity for investors to increase exposure to the sector.
We are expecting CPO prices to stay firm and trend higher into 1H17.
We estimate CPO prices at RM2,500/tonne for 2016 (2015: RM2,158/tonne) and RM2,600/tonne for 2017.

 Top picks: Singapore-listed plantation companies are still our preferred picks among the three countries.

We like Bumitama (BAL SP/Target Price: S$1.30) for its stronger earnings growth driven by positive production growth and the highest leverage to CPO prices, FR (FR SP /Target Price: S$2.65) for its efficiency in keeping costs low and it being a beneficiary of Indonesia’s biodiesel mandate, and GGR (GGR SP/Target Price: S$0.48) for its highest beta to CPO prices.

ESSENTIALS

 Neutral to positive outlook for soybean market.

We found that portfolio managers are less bearish on the soybean market now because:
1. Flat to slight decline in growth of soybean planting areas is likely. Growth of planted areas in Northern and Southern America is expected to be relatively flat after three consecutive years of expansion.
2. Weather risk – Emergence of La Nina. Historically, La Nina has posed a significant risk to the production of corn, soybeans, wheat, sugar, cotton and coffee. In the previous occurrence of La Nina in 2010, soybean futures on the Chicago Board of Trade rose by around 39%.
3. Soybean demand is still good. China has been a major buyer of global soybean for domestic demand because of poor domestic harvesting and as higher demand is expected given that hog prices have begun to regain strength.

 Major concern: Narrower discounts to soybean oil prices could trigger demand switch to soybean oil?

This is not a concern for us. Historical trends show that CPO price discounts to soybean oil narrow the year after the occurrence of El Nino due to lower CPO supply (ie at a normal discount gap of US$100-180/tonne vs post-El Nino’s US$30-50/tonne). Thus, we are expecting a similar trend and do not expect a big swing in market shares as the global vegetable oil supply is tight.

ASSUMPTION CHANGES

 No change to our CPO price assumptions.

We maintain our CPO price assumptions of RM2,500/tonne for 2016 and RM2,600/tonne for 2017.
For the near term, we expect CPO prices to weaken slightly after the strong recovery in 1Q16.
CPO prices should stay firm and potentially rise when production fails to record a strong uptrend in the coming upcycle while export growth is expected to remain relatively steady despite the high prices of CPO for export.

 The next few events to watch out for in 2H16 and 2017 are:

production trend – the market might again have to acknowledge the reality of a shortage when 3Q16 production falls far below expectations, b) demand – could remain relatively good and post marginal yoy growth despite the higher CPO prices,
domestic usage – Indonesia and Malaysia could see usage of CPO grow yoy, and
confirmation of La Nina – likely to occur in Jun/Jul 16.

SECTOR CATALYSTS

 Good progress in Indonesian biodiesel blending.

Indonesia’s state oil companies Pertamina and AKR Corporindo are expected to announce their second batch of biodiesel purchase of up to 1.6m kilolitres (kl) for May-Oct 16.
Together with the previous biodiesel contracts of 1.87m kl, the total biodiesel blending (up to Oct 16) has met the market’s expectation of 2.0-2.5m tonnes (or 2.3m-2.8m kl).
The Indonesian government targets to use close to 6m kl for B20 blending in 2016, but the market believes this target is not likely to be achieved.

 Occurrence of La Nina.

All models indicate that El Nino would weaken, with a transition to ENSO-neutral conditions likely in late-spring or early-summer 16.
Meanwhile, the chances of La Nina conditions developing would increase as we enter the fall season. Should La Nina develop this year-end, soybean production would be affected and this will lead to higher soybean prices

RISKS

Backtracking of biodiesel mandates in Indonesia and Malaysia with weak crude oil prices.
Demand rationing due to strong recovery in prices.

PEER COMPARISON

Singapore Research Team UOB Kay Hian | http://research.uobkayhian.com/ 2016-04-20

UOB Kay Hian Analyst Report BUY Maintain BUY 2.65 Same 2.65

BUY Maintain BUY 1.30 Up 1.10

BUY Maintain BUY 3.60 Same 3.60

BUY Maintain BUY 0.48 Same 0.48

HOLD Maintain HOLD 0.80 Same 0.80

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