Regional Plantations - Maybank Kim Eng 2018-12-14: 2019, A Year Of Price Recovery

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FIRST RESOURCES LIMITED (SGX:EB5) BUMITAMA AGRI LTD. (SGX:P8Z)

Regional Plantations - 2019, A Year Of Price Recovery

End-1Q19 likely the turning point

• 2018’s perfect storm will soon pass. The strong FFB growth is non-linear as we think trees will enter into biological rest after two good years of harvest.
• We see 2019 as a year of price recovery, particularly from 2Q19. That said, we cut 2018-20E CPO ASPs by 4-8% after considering current run rates.
• Sector valuation remains fair, hence our NEUTRAL weight.
• For a trade, investors can position after an expected weak 4Q18 results season in Feb 2019, ahead of a potential CPO price recovery in 2Q19. Longer term investors should consider bottom fish for bombed-out small-mid caps as stock prices tend to mean-revert over the long run.
• Our current BUYs for growth and/or undervalued stocks are First Resources, Bumitama Agri and Ta Ann.

2018’s Perfect Storm Near Tail-End

Quick recap of 2018

• 2018 has been a challenging year for the planters in this region as spot CPO price lost ~27% of its value from the start of the year to MYR1,740/t (on 10 Dec 2018; 31 Dec 2017: MYR2,390/t). With barely one month left to the end of 2018, CPO price is likely to average the year at MYR2,250/t, 19% below 2017’s MYR2,792/t average. This means that selected planters are expected to report core net losses for 2018 as CPO price has averaged below their cost of production.
• The condition is worsened by the sharply drop in palm kernel (PK, a by-product) prices, which plunged 42% over the same period to MYR1,353/t (31 Dec 2017: MYR2,329/t) which further lowered the profitability of planters. It is likely that planters (especially smallholders) have started to reduce fertiliser application amidst the low prices in 2H18. We believe this will be manifested by below-average FFB yield potential over the next 6-24 months.

Why the steep drop in CPO price?

• Basically a confluence of negatives in 2H18,
  1. Kick-started by the US-China trade tension which escalated mid-year with China imposing a 25% retaliatory import tariff on 6 July 2018 amidst abundant supply of soybean globally. The timing also coincided with the anticipated record harvest in the USA in the 2018 planting season due to good weather which pressured US soybean prices on the downside (which dragged palm oil prices along).
  2. There was a strong recovery in palm oil supply post El Nino in Indonesia (but not seen in Malaysia due to the latter’s relatively older tree age profile), the largest palm oil producer in the world, especially in 2H18 where it was reported that tanks “overflowed” due to bumper harvest, compounded with logistic constraints in Indonesia whereby some of the barges used to transport palm oil in the past were suddenly re-channelled for B20 implementation in Indonesia.
  3. Major importers have relatively weakened currencies (vs. US Dollar, namely India, China, Pakistan, China, Russia, and Myanmar) which eroded their purchasing power, resulting in weaker demand. There were also talks of insufficient US Dollar and credit constraints in Pakistan and India sometime mid-2018 which affected demand back then. But India’s demand eventually caught up towards year-end as CPO price became attractive again.

2019 To Be A Year Of CPO Price Recovery, Especially From 2Q19

FFB growth is never linear, expect a slowdown from 2Q19

• Indonesia has been experiencing a bumper harvest since the start of 2H18. In part due to the unexpected logistics constraints in Indonesia as some barges were re-channelled for biodiesel transportation to meet Indonesia’s B20 mandate, oil tanks were “overflowing”.
• We understand some millers suffered from low oil quality as FFB harvested were not processed in time (ie. not within 24 hours of harvest as the tanks were full) which resulted in formation of high FFA (“Free Fatty Acid”, ie low oil quality). This has forced millers to buy FFB at cheaper prices as they too have to sell at a discount to refiners because of the low quality. The sheer amount of oil naturally pressured CPO price on the downside resulting in the lowest CPO price in 3-years at MYR1,717/t on 21 Nov 2018.
• After one and half years of relatively good FFB harvest in Indonesia (world’s biggest producer of palm oil) post the 2015/16 El Nino, we expect oil palm trees to enter into biological rest mode in 2019, likely from 2Q19 onwards, for approximately one year.
• We witnessed similar phenomenon between July 2001 and June 2002 in Malaysia after the 1997-98 strong El Nino (where Malaysia’s average tree age profile then was still relatively young, similar to Indonesia’s profile now). After the 1997-98 El Nino, Malaysia’s FFB yields fell 9% y-o-y following two years of good harvest between July 1999-June 2001.

Weather has been generally fair in 2018

• Rainfall has been generally fair throughout 2018, except for below-average rainfall in the month of Aug-Sept around the Kalimantan region. This was evident from the increase in the number of hotspot counts compared to Aug-Sept 2017. But the hotspot count was still a far cry from that registered during the strong El Nino year of 2015 with dry bone spell that hit the region for 2-3 months.
• While the rainfalls in 2018 are generally beneficial for palm oil production in 2019, we believe the biological tree rest (especially for Indonesia) will need to happen in 2019.

Palm oil growth will slow to low single-digit in 2018/19F

• According Oil World’s projection, the palm oil production growth will slow to 4.4% (+3.2m MT) to 74.6m MT in Oct/Sept 2018/19F marketing year after posting two consecutive years of strong growth on post El Nino recovery (2016/17: +13.1% y-o-y, 2017/18F: +7.6% y-o-y). Despite slowing growth, palm oil will remain the growth leader in production among the 17 global oils & fats.
• According to Oil World, the global palm oil supply will likely moderate down in the Oct/Sept 2018/19F marketing year with a stock-to-usage ratio (SUR) estimated at 18.5%, much lower than 20.4% in the 2017/18F marketing year. At its recent peak in the 2014/15 marketing year, the SUR ratio was as high as 22.2%.
• Similarly, soybean oil, which holds the second largest share of supply (24%) among 17 global oils & fats, is also anticipated to chalk up a smaller production growth of just 0.67m MT (+1.2%) in 2018/19F, in part due to the lack of anticipated crushing activities despite ample global soybean supply. The smaller soybean oil production in 2018/19F will translate into relatively flattish soybean oil SUR of 10.2% (2017/18F: 10.1%).

Supply to trail demand growth in 2018/19F

• According to Oil World (Sept 2018 issue), the incremental global consumption (+7.4m MT) of 17 oils and fats will exceed incremental global production (+5.7m MT) in the 2018/19F marketing year, translating to a deficit of 1.7m MT.
• The deficit scenario is the first in 3 years; the last one was due to the strong 2015-16 El Nino that led to negative production growth of -1.5m MT in the 2015/16 marketing year.

Global supply of 17 oils and fats is projected to ease in 2018/19F

• According to Oil World’s forecast for the new Oct/Sept 2018/19F marketing year, palm oil supply will maintain its lion share, at approximately 32% of the global 17 oils and fats supply of 233m MT. With anticipated slowing palm oil production growth in Malaysia and Indonesia, the global 17 oil & fats supply situation will moderate slightly.
• According to Oil World, the global 17 oils & fats stock-to-usage ratio (SUR) is projected to ease to 13.0% in the Oct/Sept 2018/19F marketing year (2017/18F: 13.3%) but still below its past 5 years’ average SUR of 13.9% and the peak SUR of 15.7% recorded in 2014/15 marketing year.

The stock build-up is at the oilseeds, especially soybean

• Argentina, the world’s third largest soybean producer, after USA and Brazil, suffered a devastating drought in early 2018. The losses were so huge that soybean crop harvest fell to 35.5 MT in 2017/18F marketing year, a 35% y-o-y reduction from a year ago. In 2018/19F, if weather permits, Argentina’s soybean output is expected to recover to normalized level of ~51.0m MT (+44% y-o-y). Likewise, if weather permits, Brazil - the second largest global soybean producer - is likely to produce record soybean output estimated at 122.0m MT (+1% y-o-y) in 2018/19F, capitalizing on the US-China trade tension.
• Coupled with the record harvest in the US this year, Oil World forecasts a +7.2% y-o-y FFB growth in soybean production. However, due to the US–China trade tension with anticipated trade disruption as China is traditionally the largest buyer of US’s soybean, this will lead to a sharp build-up in US soybean stocks which, in turn, will lead to higher global soybean SUR at 30.5% in 2018/19F marketing year (2017/18F: 26.7%), the highest ratio in 12-years.
• Overall, soybean leads the global 10 oilseeds production with at least ~60% share of global 10 oilseeds supply. Consequently, the higher soybean supply is expected to drive up the global 10 oilseeds SUR too to 21.6% in 2018/19F marketing year (2017/18F: 19.1%).

Weakness in Argentinean Peso and Brazilian Real favour more soybean planting

• The Brazilian Real and Argentinean Peso have fallen more than double-digit against the US Dollar in 2018 with the latter having it worse as it had declined 50% since the start of the year. The weakened currencies are a blessing in disguise for the Argentinean and Brazilian farmers as soybean (and other grains), traded in US Dollar in the export market, provides a good shelter and work as a hedge. Furthermore, the US-China trade tension has provided South American farmers with added incentives to pursue their planting of soybean (if weather and financial condition permits).
• For 2018/19F marketing year, Oil World is presently forecasting a record Brazil soybean harvest of 122m MT (+1% y-o-y), and a sharply higher Argentina soybean harvest of 51m MT (+44% y-o-y) after bad weather hurt 2017/18’s yield.

Discretionary biodiesel demand is still economically viable

• Increase in palm biodiesel usage is crucial in helping a quicker drawdown in palm oil stockpile. As palm oil prices continue to trade at a discount to crude oil prices since May 2018, the discretionary palm biodiesel demand will continue to be reinvigorated. In recent years, the biodiesel interest was largely concentrated on mandatory biodiesel blend (ie non-discretionary demand) that are government mandated (like the EU, USA, Indonesia, and Malaysia) which may or may not come with government subsidies.
• CPO price is now trading at a discount instead to gas oil (ie diesel) in Europe. The palm oil-gas oil spread or popularly known as POGO spread is favourable in the Europe, the world’s biggest biodiesel market. As at 10 Dec 2018, the POGO spread stood at -USD96/t (ie palm oil trading at discount to gas oil), a reversal from last year’s premium of +USD93/t.
• Unfortunately, the demand for palm biodiesel in the Northern Hemisphere tends to be more muted during the winter months given the relatively high pour point of normal palm biodiesel at ~15˚C. However, there are low pour point (ie winter grade) palm biodiesel (-21˚C to 0˚C) which can cater for seasonal requirements, albeit at higher cost. Therefore, at this season of the year, Indonesia and Malaysia need to step up the usage of palm biodiesel to quickly help reduce the ample palm oil stockpile.

Things To Watch Out For In 2019

1. The new threshold in Indonesia’s export tax is a possible game changer for the industry
2. El Nino to make a comeback in 2019?
3. M&A theme to pick up in 2019.
4. India may cut import taxes on palm oil from 1 Jan 19.
5. Rising palm biodiesel usage in Indonesia and Malaysia
6. Rising cost pressures from labour and fertiliser.

• Refer to the PDF report attached for details.

Revisiting CPO ASP forecasts

Lowering to MYR2,250/t (-200/t) for 2018, MYR2,350/t (- 150/t) for 2019, …

• We revise downwards our 2018 CPO ASP forecast to MYR2,250/t (from MYR2,450/t, -8%), which is now ~19% below 2017’s spot CPO ASP of MYR2,792/t. However, in USD terms, our CPO ASP forecast cut is even higher at USD588/t (- 10%) given the weaker Ringgit assumption of 4.03 (previously 3.95). As for 2019, we also cut our CPO ASP forecast by -6% to MYR2,350/t (previously MYR2,500/t). Based on our revised FX assumption of USDMYR 4.10 for 2019, our revised CPO ASP forecast of MYR2,500/t translates into USD573/t (previously USD633/t).
• We consider the current low CPO price at ~USD420/t, its lowest in 12-years and which is just a tad higher than GFC low of USD390/t on 18 Nov 2018, as unsustainable as a lot of industry players will suffer losses or merely breakeven given recent increases in cost of production and into 2019 as well.

… and to MYR2,500/t (-100/t) for 2020

• Likewise, we also cut our 2020 CPO ASP forecast by -4% to MYR2,500/t (from MYR2,600/t). In 2020, we believe the region’s production growth will decelerate further due to
  1. lack of new oil palm planting in recent years on Indonesia’s forest moratorium and more stringent new planting requirements, and the less attractive returns of palm oil investment compared to 7-8 years ago, and
  2. the need to do more aggressive replanting in both Malaysia and Indonesia as some of the trees are simply too old.

Also, revising earnings forecasts for some in our coverage

• With our revised CPO ASP forecasts, the ensuing earnings impacts and revision to target prices and calls (if any) for our stock coverage are highlighted in the individual company write-ups, in the ensuing pages. We have cut our earnings forecasts for the small-mid cap players in the recently concluded results season.
• In general, purer upstream planters and companies with relatively higher cost of production will experience higher earnings cut.

Strategy for 2019

• Our fundamental sector weight remains a NEUTRAL as sector valuation remains fair for 2019.
• Over the immediate term, catalysts are lacking to drive share price performance amidst ample palm oil supply. Also, 4Q18 results reporting in Feb 2019 may see persistent weak earnings; 4Q18 earnings may not be any better than 3Q18 as CPO price has dipped further to below MYR2,000/t since early Nov 2018 – see our sector note on 7 Dec 2018 entitled “Malaysia Plantations -4Q18 results could be just as weak”.
• Nonetheless, we believe these near term negatives have been largely priced in judging from the steep share price corrections of planters (especially purer and less efficient planters), and in particular the small-to-mid cap companies – see Fig 35 in the PDF report attached. The sector is going through psychological bearishness as CPO price has trended below the cost of production for the less efficient planters, with several companies posting losses during the recent results season.
• It is important to acknowledge that Ringgit has weakened against US Dollar and the industry’s overall cost of production (per CPO tonne) has risen sharply over the years. And in 2018, as PK price (oil palm’s by-product) has fallen sharply, the impact on cost of production (as measured on a per CPO tonne basis) has been even more vivid.
• Beyond ample supply issues and a weak 4Q18 results reporting season in early- 2019 however, we believe there are trading opportunities for investors in 2Q19. History has shown that low CPO prices usually last for about six months before price recovery sets in as producers cannot afford to continuously sell below cost over an extended period of time. This was evident in 2000-01 and again in 2008-09 (see Fig 36 & 37 in the PDF report attached).
• In this current cycle of price weakness, we believe we are already into the third month of low CPO prices; this could potentially extend for another 2-3 months. If history were any good as guides, a meaningful price recovery could set in, likely in 2Q19.
• When prices are ridiculously low like now, the natural reaction of smaller, less efficient palm oil producers will be to cut or stop fertilizer application altogether or even stop harvesting. As for the competing oilseeds like soybean, the low prices of soybean will also force farmers to switch to other more profitable crops in their next annual planting plan. Hence, we do expect US farmers to plant less of soybean in the 2019 season, which will aid price recovery from 2Q19 onwards.
• For the medium term, we advocate accumulating stocks that provide good medium-term growth prospects (supported by relatively younger tree age profile) and/or stocks that are undervalued. Our preferred BUY picks in the region are First Resources (FR SP), Bumitama Agri (BAL SP), and Ta Ann Holdings (TAH MK).

Company Reports

• First Resources - A Well-Managed Planter.
• Bumitama Agri - High Output Growth Weathers Low Prices.

Ong Chee Ting CA Maybank Kim Eng Research | https://www.maybank-ke.com.sg/ 2018-12-14

SGX Stock Analyst Report BUY MAINTAIN BUY 2.100 SAME 2.100

BUY MAINTAIN BUY 0.960 SAME 0.960