Regional Plantation Stocks - DBS Research 2018-07-02: Scope For CPO Prices To Rebound

Regional Plantation - DBS Vickers 2018-07-02: Scope For Cpo Prices To Rebound

Plantation Stocks Crude Palm Oil CPO Price BUMITAMA AGRI LTD. SGX:P8Z FIRST RESOURCES LIMITED SGX:EB5 WILMAR INTERNATIONAL LIMITED SGX:F34 INDOFOOD AGRI RESOURCES LTD. SGX:5JS

Regional Plantation - Scope For CPO Prices To Rebound

We forecast CPO price to average at RM2,800 per MT in second semester this year.
Exports to rebound from May low.
Slower output growth in 2H18-stockpile level to normalize below 2.0MT.
Our top picks are Astra Agro (AALI), London Sumatra (LSIP), Bumitama (BAL), First Resources (FR), Wilmar (WIL) and TSH Resources (TSH).

Where we differ: 2019 average CPO price at RM2,600 per MT (US$608 per MT).

We believe that CPO prices will not stay at the current low levels and, are set to rebound and average RM2,800 per MT in 2H18.
For CY18, we forecast that the average CPO price will come in at RM2,620 per MT (US$616 per MT), before normalising to RM2,600 per MT (US$608 per MT) in CY19.

Slower output growth in sight in 2H18.

There are two key factors –
1. the dissipating bumper crops effect, as seen the stronger than expected output in 1H18,
2. lower pollination of trees from 4Q17 due to the rainy season, have seemingly slowed down production and this was apparent in May 2018.

Exports recovery to support prices.

On the demand side, we expect recovery in biodiesel blending activities to track the still firm crude oil price outlook for the rest of this year – this support demand beyond existing food-based consumption.
Exports to major countries such as the European Union (EU), India and China are set to rebound on seasonal restocking, coupled with CPO’s price affordability vs. other edible oils.

Tepid share price performance presents accumulation opportunities.

Regional CPO planters’ share prices have underperformed the respective country’s benchmark indices and we believe that weak CPO price is the key concern.
Assuming that the weak earnings in 1H18 have already been priced in, we believe that the market expects only modest earnings growth in 2019 in view of the depressed valuations of regional CPO planters (i.e. at 4-year lows). As such, we keep our selective stance by having Astra Agro (AALI), London Sumatra (LSIP), Bumitama (BAL), First Resources (FR), Wilmar (WIL) and TSH Resources (TSH) as our top picks, given their strong organic growth prospects for both new plantings and yield expansion.

Our key message

CPO price to gain traction in 2H18

Our 2018 average CPO price forecast of RM2,620 per MT (US$616 per MT) implies a sequential recovery for the rest of the year, before inching down again in 2019 to RM2,600 per MT (US$608 per MT). We believe our CPO price forecast is conservative, accounting for our conservative stance over biodiesel demand absorption and a steady outlook for supply and demand with regard to other edible oils.
We see the scope for CPO prices to rebound in 2H18 on lower production growth potential. Note that the dissipating bumper crops effect, as seen in 1H18, and lower pollination of trees from 4Q17 due to the rainy season have seemingly slowed down production and this was apparent in May 2018.
Meanwhile, we believe the impact of any US-China trade war on CPO prices will be minimal, given the fact that China has historically purchased CPO only to counter any domestic soybean oil shortage. A key upside risk for CPO demand could arise if China could not replace US soybean with supply from another country, mainly from South America, or its own domestic acreage. This means that CPO demand may gain traction in response to higher China edible oil consumption or even better, structurally higher CPO demand from China.

CPO exports to rebound, mainly to EU countries

On the demand side, we expect higher biodiesel blending demand to track the still firm crude oil price outlook for the rest of this year – this support demand beyond existing food- based consumption. Exports to major countries such as the European Union (EU), India and China are set to rebound on seasonal restocking, coupled with CPO’s price affordability vs. other edible oils.
Moreover, the EU has just deferred its total phase-out of CPO- based biodiesel for transport usage to 2030 from 2021 previously – as this will provide some degree of certainty to CPO importers and buyers, we believe CPO exports to EU will rebound in 2H18.
CPO stockpile will stay at around 2.0m MT in 3Q17, thanks to the weaker output growth outlook in 2H18 that is expected to sufficiently offset the dim export prospects in the June-July period, before seeing a potential drawdown to 1.7m MT by year-end and 2019.

Structural supply downside risk being underestimated by the market

In the long term, we believe CPO prices will continue to be strong on the back of tight supply-demand conditions given the limited land for new planting, mainly for potential new entrants in making large-scale output expansion.
Meanwhile, long-term CPO demand will be steady, given the strong demand from various food-based applications.

Selective choice of planters with sound organic growth prospects

Positioning for the theme of strong CPO prices in the long term, we like CPO planters that can capitalise on buoyant CPO prices and have robust growth potential, both organically or inorganically.
We like CPO planters that have a young tree profile, which can provide organic output growth and yield expansion, thus potentially keeping the cash cost per ton low. The names on our radar are Astra Agro (AALI), London Sumatra (LSIP), Bumitama (BAL), First Resources (FR), Wilmar (WIL) and TSH Resources (TSH).

We are still picking planters with yield expansion potential

Regional CPO stocks have underperformed each respective country’s index since last year. CPO price remains a key factor that can determine the sentiment towards the sector – keeping in mind that issues like India’s import tax hike and EU countries’ attempts to curb CPO-based biodiesel can also impact CPO price and inventory.
However, in this report, we will highlight that changing structural demand is not going to be easy, given the affordability and availability of CPO. On the other hand, output expansion will also be challenging. This scenario provides a positive picture for supply and demand dynamics with regard to CPO prices.
We also believe the market is currently under-appreciating palm oil planters, as evidenced by the inexpensive PE valuation for these stocks, which is below the five-year average. The market’s scepticism is well understood and this is attributable to their muted 1Q18 earnings performance, which is at the bottom range of our forecast due to a lower CPO price trend, coupled with soft output expansion.
As such, we believe CPO stocks are undervalued and trading at a discount. Investors can position for tight supply-demand conditions by accumulating our picks in the sector, as these stocks are pure CPO price plays, and their volume expansion could also boost their earnings performance.

Earnings revision

Despite keeping our overall price assumptions, we take this opportunity to conduct some selective earnings adjustments for CPO planters in our universe that domiciled in Indonesia, mainly for the lower-than- expected ramp-up in operational scale from yield expansion. Looking at the across-the-board share price performance, we believe CPO stocks have also baked in expectations of relatively modest earnings growth, after a slow start in 1Q18.
We conservatively assume a slower sequential earnings expansion for the rest of this year and next, due to higher production costs (pertaining to fertilisers and third-party fruit purchases). We checked that several fertilizing activities are still ongoing in 2Q this year and most likely persist in 3Q due to relatively dry weather. We will only see the strongest earnings contribution of the year in 4Q this year.
We see earnings recovery momentum in 2019 on normalizing production cost outlook per ton. Yield expansion also to support profitability performance due to better economic of scale – estates plantation cost escalate pegging the inflation, such as labour wages, in per hectare basis.
This outlook also prompt us to reiterate our stock picking strategy – we only choose companies with yield expansion and volume growth potential as it will keep the cost low and earnings growth amid the relatively flattish y-o-y CPO price expansion in 2019. We assume CPO price at US$608 per MT (RM2,605 per MT, -4% y-o-y).

Company Reports

William Simadiputra DBS Vickers | Rui Wen LIM DBS Vickers | https://www.dbsvickers.com/ 2018-07-02

SGX Stock Analyst Report BUY Maintain BUY 0.88 Down 0.940

BUY Maintain BUY 2.00 Down 2.180

BUY Maintain BUY 3.50 Down 3.650

HOLD Maintain HOLD 0.24 Down 0.360

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