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Golden Agri-Resources - UOB Kay Hian 2016-03-02: Weaker Upstream Compensated By Better Downstream Operations

Golden Agri-Resources - UOB Kay Hian 2016-03-02: Weaker Upstream Compensated By Better Downstream Operations GOLDEN AGRI-RESOURCES LTD E5H.SI 

Golden Agri-Resources (GGR SP) - Weaker Upstream Compensated By Better Downstream Operations 

  • The severe dry weather in 2015 is likely to cut Golden Agri-Resources’ 2016 FFB production by 5-10% with a bigger decline to come from plasma areas. 
  • To mitigate the decline in production, tighter cost control will be implemented but low fertiliser prices will mitigate the cost pressure. 
  • Management is confident of maintaining its downstream performance after ceasing the loss-making operation in China and expanding sales of high-margin end products. 
  • Maintain BUY. Target price: S$0.44. 


WHAT’S NEW 


• We are keeping our earnings forecasts post results briefing. 

  • Although management sounded more concerned over the larger decline in production after very low production in Jan 16 and early-Feb 16, we are sticking to our forecast of a 3% yoy decline in 2016 production vs management guidance of a 5-10% drop. 
  • Downstream contribution surged to 20% in 2015 and is likely to stay at 15-20% in 2016 as the upstream operation is not able to fully capture the better selling prices due to contraction in production. 


Key takeaways from 4Q15 results briefing: 


• FFB production to drop 5-10% in 2016. 

  • Plasma areas in Riau/Jambi are likely to see the highest impact from low rainfall. This is in line with the guidance from other plantation companies. We are expecting a 3% decline in production in 2016 for now. 
  • New milling capacity (added 1.2m tonnes in milling capacity towards end-15) should be able to process more third-party FFB to increase CPO production in 2016. Another new mill is expected to be built in 2016 to cater to production from new mature areas. 

• CPO could trade up to US$700/tonne vs US$600-610 currently. 

  • Management opines that current CPO prices do not fully reflect the potential tight supply and biodiesel blending in Indonesia. 
  • We are expecting CPO prices at US$550-700/tonne for 2016 with an average at US$600/tonne (RM2,500/tonne). 

• More stable contribution from downstream. 

  • Management is confident that its downstream operations in Indonesia and China will stay profitable and margins achieved in 2015 will be sustainable. This follows the closure of its loss-making operations in China and expansion of more end-market products to mitigate the highly volatile refining margins. 
  • We forecast 2016 EBITDA margins at 1.4% (2015: 1.5%) and 1.6% (2015: 1.4%) for the palm & lauric and the oilseeds divisions respectively. 


STOCK IMPACT 


• Higher unit cost of production due to lower production. 

  • Cost of production is expected to increase 11% to US$310/tonne in 2016 (2015: US$279/tonne) due to lower production and higher labour cost. This is in line with our expectation. 

• No new planting; more replanting with higher-yielding seeds. 

  • Golden AgriResources (GGR) planted only 374ha of new areas under the plasma scheme and expects to plant another 400ha under plasma in 2016. New planting in nucleus area is put on hold until it resolves the complaints at RSPO (Roundable of Sustainable Palm Oil). 

• First biodiesel plant to start operation by 3Q16. 

  • GGR plans to have two biodiesel plants with a total capacity of 600,000 tonnes per year. The first plant should be ready by 3Q16 to bid for the year-end tender by Pertamina. 


EARNINGS REVISION/RISK 

  • Maintain our net profit forecasts for 2016-18 based on CPO price assumptions of RM2,500/tonne, RM2,600 and RM2,500 respectively. 
  • We see lower CPO prices in 2018 on expectation of a recovery in CPO production. 


VALUATION/RECOMMENDATION 


• Maintain BUY and target price of S$0.44, based on 15x 2016F PE, or its 5-year average. 

  • GGR is one of the plantation stocks with a high beta to CPO prices. In view of the expected rise in CPO prices on the back of tight supply and decent demand growth coming from Indonesia biodiesel usage, we expect GGR’s share price to track CPO price trend if GGR continues to meet earnings expectation. 


SHARE PRICE CATALYST 


• Better-than-expected CPO prices. 

  • As one of largest upstream players in the sector, GGR has the highest leverage to CPO prices. 

• Merger and acquisition. 

  • Given GGR’s large-scale upstream operations and production, GGR can benefit significantly if it expands its downstream operations to capture the full value chain. 
  • A strategic tie-up or a JV with a company that can provide better market access will be positive for GGR. 

• Disposal of non-core operations, ie oilseed operation in China. 

  • This division does not contribute much to the group and sees volatility in its operations. GGR will benefit from the disposal of this business and it should concentrate on expanding its palm operations.



Singapore Research Team UOB Kay Hian | http://research.uobkayhian.com/ 2016-03-02
UOB Kay Hian SGX Stock Analyst Report BUY Maintain BUY 0.440 Same 0.440


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