Plantation - UOB Kay Hian 2016-03-31: Firm CPO Prices Reflect Supply Tightness

Plantation - UOB Kay Hian 2016-03-31: Firm CPO Prices Reflect Supply Tightness Plantation Sector FIRST RESOURCES LIMITED EB5.SI  BUMITAMA AGRI LTD P8Z.SI  WILMAR INTERNATIONAL LIMITED F34.SI  GOLDEN AGRI-RESOURCES LTD E5H.SI  NDOFOOD AGRI RESOURCES LTD 5JS.SI 

Plantation – Singapore Firm CPO Prices Reflect Supply Tightness 

  • As expected, CPO prices have strengthened on expectations of supply tightness post-El Nino in 2015. This trend should stay firm even in 1H17. 
  • We maintain our CPO price assumptions of RM2,500/tonne for 2016 (vs ytd: RM2,410/tonne for spot prices) and RM2,600 for 2017. 
  • Plantation stocks should continue to outperform and we upgrade our target prices as we roll over our valuations to 2017. 
  • Top picks: BAL SP, FR SP and GGR SP. Maintain OVERWEIGHT. 


WHAT’S NEW 


• CPO prices reacting to low production. 

  • CPO prices are finally trending upwards as expected. Ytd, CPO spot prices increased by about 21% to RM2,670/tonne as at 29 Mar 16, the highest since end-Apr 14. CPO prices began to rise after: 
    1. Malaysia reported very low production in Feb 16, 
    2. Indonesia recorded strong exports but weak production, and 
    3. recovery in palm oil production for Mar 16 could be weaker than expected. 
  • CPO prices should stay firm as we are not likely to see any strong recovery in production any time soon. 

• Discount to soybean prices narrow. 

  • After the recent strong price uptrend, CPO prices’ discount gap to soybean oil (SBO) narrowed substantially and this might trigger concerns of substitution in price sensitive markets. 
  • In addition, the current CPO prices upside could be capped by the soybean supply from South America starts to enter the export market. 
  • In the past, CPO prices did trade higher than SBO prices when CPO supply was tight (1998/99, 2010/11) for a couple of months to a year (in 1998/99). 
  • We might see this premium happen again in 3Q16 if peak CPO production does not take place and when the seasonally large flow of supply of soybean from South America comes to an end. 

• Upgrade target prices – roll over to 2017F EPS. 

  • We roll over our target price valuation bases to 2017F EPS from 2016F EPS as share price performances in the next 12 months should reflect the potentially higher earnings growth of plantation companies in 2017. 
  • However, we are keeping Wilmar’s target price valuation based on 2016 projections as its earnings visibility is not as great as those of pure plantation companies and it has less leverage to the rising CPO prices. 

• Beta to CPO prices. 

  • Based on a correlation analysis, Golden Agri (GGR) remains the highest beta stock to CPO prices (refer to correlation bar charts). This stock tends to move in tandem with CPO price movements. 
  • First Resources’ (FR) correlation to CPO prices was skewed by its strong performance during the low CPO price period, which is reflective of its strong earnings growth underpinned by its ability to sell at higher prices and deliver better refining margins vs peers in 2013-14. 


ACTION 


• Maintain OVERWEIGHT. 

  • We expect CPO prices to stay firm for the rest of 2016 and the prices should remain high into 1H17. 
  • We are expecting an average CPO price of RM2,500/tonne for 2016 (2015: RM2,158/tonne) and a higher price of 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 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 

  • Our observations on the soybean market suggest that soybean planting could see a decline in the next planting season. 
    1. SBO price was the strongest within the soybean complex. This was supported by the stronger CPO prices as both products are highly correlated. Soybean is still in oversupply. 
    2. Argentina looking to plant more wheat and corn at the expense of soybean. Based on an Oil World report dated 24 Mar 16, soybean planting area and production is likely to decline in early-17. Wheat and corn will be the big winners in the forthcoming planting campaign, following the significant improvement in profitability in the agricultural sector under the new government. 
    3. Soybean might lose some acreage to corn in next round of US planting as the soybean/corn price ratio is declining. Planting soybean is not as lucrative as it was in 2014 and the soybean/corn price ratio is now down from the peak of 3.5x to around 2.5x. This might have some farmers allocating more area for corn planting. This could be positive news for the vegetable oil market. 


ASSUMPTION CHANGES 

  • We maintain our CPO price assumptions of RM2,500/tonne for 2016 and RM2,600/tonne for 2017. Ytd, the average spot price is around RM2,410/tonne. For 2016, CPO prices on average could be better than our assumption. 
  • Upstream players’ earnings have a high leverage to CPO prices. Based on our earnings sensitivity, GGR has the highest earnings leverage to CPO prices, followed by FR and BAL. 


RISKS 

  • Backtracking of biodiesel mandates in Indonesia and Malaysia after the recent fall in crude oil prices. 


SECTOR CATALYSTS 


• Weather disruption. 

  • Agricultural production is impacted by extreme weather. Any negative impact from the weather would be positive to prices. 

• Occurrence of La Nina. 

  • Should La Nina develop this year-end, soybean production will be affected and this will lead to higher soybean prices.

PEER COMPARISON 




Singapore Research Team UOB Kay Hian | http://research.uobkayhian.com/ 2016-03-31
UOB Kay Hian Analyst Report BUY Maintain BUY 2.65 Up 2.00
BUY Maintain BUY 1.30 Up 1.10
BUY Maintain BUY 3.60 Same 3.60
BUY Maintain BUY 0.48 Up 0.44
HOLD Maintain HOLD 0.80 Same 0.80


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