Regional Plantations - Maybank Kim Eng 2019-06-28: A Better 2H In The Making

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

Regional Plantations - A Better 2H In The Making

Slowdown in output to drive price appreciation

• We cut our CPO ASP for 2019-21 by 6%-11% to MYR2,100/2,300/2,400/t on weaker-than-expected 1H19 spot CPO ASP. Nevertheless, much of the negatives have been priced in, in our view, and the slowdown in palm oil output growth should trigger improved CPO prices in the next 12-18 months.
• Our 12M NEUTRAL view on the sector is unchanged as the Malaysian large-caps have largely priced in CPO price recovery. But long funds should consider taking the opportunity to accumulate bombed out small-mid caps during this down-cycle.
• Our BUYs are First Resources and Bumitama Agri, Ta Ann & Sarawak Oil Palms.

Quick recap of 1H19

• Despite CPO spot price having recovered from its low of MYR1,717/t in Nov 2018, 1H19 spot CPO ASP of MYR1,993/t (1H19’s 3M CPO ASP: ~MYR2,136/t) has largely underperformed our expectation. The high brought forward stockpile of 3.22mt (million tonnes) at the start of 2019 and surprisingly strong output in 1Q19 had kept stockpile stubbornly high throughout Jan-Apr 19.
• Sentiment was subsequently affected by the unexpected escalation of US-China trade war in May 2019 as US raised tariffs on USD200b imports from China to 25% (from 10% in Sept 2018). The market had initially responded negatively to the revised trade war measures, driving 1M soybean and corn futures prices to their 11-year and 8-months low respectively, before the market started to price in weather risk in the USA.
• The excessive rainfall and flood in the USA over the past two months has resulted in significant delays in the plantings of corn and soybean. Over the same period, the African Swine Fever (ASF) in China has added to the overall bearishness in the soft commodity segment as demand for animal feed in China fell to reflect lower demand from the swine industry. It was reported that ~20% of China’s swine herd, the equivalent of 80m swine, has been impacted by ASF already.

Anticipation of a stronger CPO price recovery in 1H19 now pushed back to 2H19

The cure for low price is low price itself

• The stubbornly high stockpile till April 2019 and the subsequent the escalation of US-China trade war in May 2019 had prevented a more meaningful CPO price recovery throughout 1H19. CPO price is near its multi-year low, both in MYR and USD terms. The only positive is that the low palm oil price over the past 9 months has boosted demand for palm oil. According to Oil World’s latest data, palm oil’s global exports grew 7.2% to 26.77mt in Oct/Mar 2018/19 period compared to the same period a year ago.
• As cliché as it sounds, industry experts are often quoted as saying that the cure for low CPO price is low price itself. Indeed, the stronger demand over the past months has brought down stockpile to a more manageable level. In Jan-May 2019, Malaysia reported a drawdown in stockpile by 0.8mt (-24%), as exports (+12%) outpaced production growth (+10%).

Expect a slowdown in FFB output

• We maintain our view that after two years of relatively strong output post the strong El Nino in 2015/16, we now anticipate the region’s FFB output will enter into its biological rest mode. Indonesia, the world’s biggest producer of palm oil, has been experiencing a bumper harvest since the start of 3Q18. Meanwhile Malaysia’s bumper harvest only happened in 4Q18, which extended into 1Q19. Coupled with the lack of fertilizing applications, especially by smallholders who account for ~30-40% of total oil palm planted area in the region, due to depressed CPO prices for the last 9-12 months, we expect a slowdown in FFB output in the coming months from 2Q19.
• We believe history is likely to repeat itself. This was evident from the drop in Malaysia’s FFB yield between July 2001 and June 2002 following similarly strong El Nino in 1997-98 (comparable to the 2015-16 El Nino). Following two years of good harvest between July 1999 and June 2001 post the strong 1997-98 El Nino, Malaysia’s FFB yields fell 9% y-o-y in the period between July 2001 and June 2002. There is early indication among listed planters operating in Indonesia that output has fallen sharply y-o-y in Apr-May 2019, in part due to the very high base recorded in 2Q18.

Palm oil growth is expected to slow further in 2019/20F

• Our anticipated slowdown in output in the coming quarters is also echoed by Oil World’s latest projections for the coming year. In Oil World’s initial projection for Oct/Sept 2019/20F marketing year released on 14 June, palm oil production growth is expected to slow to 2.8% (+2.1mt to 77.7mt), its slowest in 10 years (excluding the contraction in 2015/16F marketing year affected by the strong El Nino). This is on the heels of an already slower Oct/Sept 2018/19F marketing year growth forecast of 5.0% y-o-y to 75.6mt, after posting two consecutive years of strong growth post El Nino recovery (2016/17: +13.7% y-o-y, 2017/18: +7.9% y-o-y).
• Despite slowing growth, palm oil will maintain its lion share at ~32% of the global 17 oils and fats supply of 240mt (according to Oil World’s forecast for the new Oct/Sept 2019/20F marketing year).
• According to Oil World, the global palm oil supply will likely turn tighter in the Oct/Sept 2019/20F marketing year with a stock-to-usage ratio (SUR) estimated at 17.4%, lower than 18.9% in the 2018/19F marketing year and 5-year average SUR of 19.0%. At its recent peak in the 2017/18 marketing year, the SUR ratio was as high as 21.1%.
• In contrast, soybean oil - the second largest contributor to supply (at 24%) among the 17 global oils & fats, is anticipated to grow faster as +3.3% (+1.85mt) in 2019/20F (2018/19F: +0.6% y-o-y). The 2019/20F soybean oil SUR is anticipated at 10.3% (2018/19F: 10.8%), slightly below the 5-year average SUR of 10.5%.

Global supply to trail demand growth for a second year

• According to Oil World (June 2019 issue), the incremental global consumption (+6.3mt) of the global 17 oils and fats will once again exceed incremental global production (+5.2mt) in the 2019/20F marketing year, translating to a deficit of 1.1mt. This deficit scenario will be narrower than 2018/19F’s -3.9mt. The deficit scenario will result in a further drawdown in stockpile.

Tighter projection in 2019/20F marketing year

• With the projected slowing palm oil production growth in Malaysia and Indonesia, the global 17 oil & fats supply situation will be tighter relative to recent history. According to Oil World, the global 17 oils & fats stock-to-usage ratio (SUR) is projected to ease further for a second consecutive year to 12.9% in the Oct/Sept 2019/20F marketing year (2018/19F: 13.6%; 2017/18: 14.1%). If it materializes, this will be below past 5-year average SUR of 13.7% and way below the peak SUR of 15.8% recorded in 2014/15 marketing year.

Ample oilseeds contrast with moderately tight oils supply

• Oil World forecasts the world production of 10 oilseeds to decline slightly in 2019/20F to 580.9mt (-1.7mt) in its initial forecast, breaking a 3-year growth streak. El Nino or not, the weather risk is high for 2019 and has created uncertainties in the oilseeds’ initial forecast not just in the USA, but also in Canada, Ukraine, Russia and China. In the USA, the world’s largest producer of soybean, soybean plantings this season have been significantly delayed by the recent excessive rainfall. The window to plant soybean in the US is coming to an end as soybean planting is typically completed before the end of June. And because the planting has been delayed, its yield potential is also questionable. The next milestone to watch is weather conditions between July and September, especially during the crucial pod setting period (ie crop development) in August.
• Soybean, with its largest share of the global oilseeds supply at ~61%, is expected to lead the decline in 2019/20F oilseeds supply. Yet, the overall supply of global soybean is expected to remain ample after 3 years of good harvest. Despite lower soybean supply in 2019/20F, the global soybean SUR is still expected to be relatively high at 30.3%, but a tad lower than the 2018/19F peak of 31.8%.

Consequently, the lower soybean supply is expected to bring down the global 10 oilseeds SUR off its recent 2018/19F peak of 22.5% to 21.5% in 2019/20F. Still, we expect the global oilseeds, especially that of soybean, to remain in ample supply.

• The weaker prospect of US soybean output this season may help mitigate weaker demand emanating from the US-China trade tension coupled with the nationwide African Swine Fever (ASF) outbreak in China. The latter has resulted in lower soybean crushing activities, and the need to raise imports of vegetable oils.
• According to the Oil World report, China’s import of soybean fell 16% y-o-y in the October/April 2018/19F to 42.4mt. Conversely, China boosted the purchase of vegetable oils to compensate for the decline in soybean purchase. Palm oil benefited the most as imports of palm oil rose by 0.55mt or +17% y-o-y to 3.84mt over the same period.

Palm biodiesel demand to pick up in 2019 & 2020

• Indonesia has recorded exceptional growth in biodiesel usage in 2018 following the strict enforcement of the B20 implementation, further encouraged by improved logistics and favorable POGO spread (ie palm oil-gas oil spread). The POGO spread in Europe averaged -USD43/t in 2018, and -USD78/t in 1H19, as palm oil has mostly traded at a discount to gas oil (ie diesel) since May 2018 (see Fig 16). According to Oil World, Indonesia led the growth in biodiesel production last year with 5.32mt (+2.4mt in 2018; an 82% y-o-y growth). Of this, 1.56mt of palm biodiesel was exported. In 2019, Oil World estimates Indonesia to raise biodiesel production by 1.98mt to 7.30mt or +37% y-o-y, with the bulk of the growth channeled for domestic use.
• According to Oil World too, contrary to news about initiatives in Europe to reduce palm oil usage in biofuels, the EU’s consumption of palm oil is set to establish a new record in 2019 at 3.89mt (2018: 3.80mt). In fact, 2019 will be the benchmark for the next few years and palm oil usage for biodiesel will only be reduced step by step in the years ahead. The low CPO price in 1H19 may have inevitably helped to stimulate EU’s demand for palm biodiesel.
• According to Pak Arif Rachmat of Triputra, a speaker at the annual Palm Oil Conference 2019 back in March, Indonesia’s biodiesel usage in the PSO (Public Service Obligation) and non-PSO segments totaled ~3.9m kiloliters (KL) or 3.35mt in 2018, an increase of 48% y-o-y. In 2019, he forecasts demand for PSO and non- PSO will reach ~6.2m KL (+60% y-o-y).
• In 2020, Indonesia plans to further raise its palm biodiesel demand via a B30 mandate (i.e. 30% palm-biodiesel mix with diesel), from B20. It has commenced testing of B30 usage last week. If Indonesia successfully implements its ambitious B30 mandate in early 2020, this may boost Indonesia’s palm biodiesel demand to 7m KL according to one source. This, in turn, will help reduce stockpile and lift palm oil prices.
• As for Malaysia, there are talks the government is pushing for a B20 mandate (presently B10). The B10 mandate was estimated to consume about 0.76mt of palm oil annually. A doubling of mandate may just double the palm biodiesel use to 1.5mt annually. While the news is positive on paper, the worry is the plan could be derailed if the POGO spread turns positive with palm oil price trading higher than gas oil, as this would require a larger subsidy which the Malaysian government can ill afford over the longer term.
• According to a recent media report, the government has formed a special joint committee headed by the Ministry of Primary Industries to monitor and ensure that the implementation of the B20 biodiesel fuel next year will proceed smoothly. There is suggestion that Malaysia is looking to establish a biodiesel stabilisation fund to make the biodiesel price more attractive to customers.

Revisiting CPO ASP forecasts

Lowering to MYR2,100/t (-250/t) for 2019, MYR2,300/t (- 200/t) for 2020, …

• We consider the current low CPO price at ~MYR2,000/t as unsustainable as a number of industry players will suffer losses or merely breakeven given labour and fertilizer cost pressures in recent years.
• Nonetheless, given the low spot CPO ASP achieved of MYR1,993/t in 1H19, we revise down our 2019 CPO ASP forecast to MYR2,100/t (from MYR2,350/t, - 10.6%), which is now 6.0% below 2018’s spot CPO ASP of MYR2,235/t. In USD terms, our CPO ASP forecast cut is slightly steeper at USD508/t (-11.3%) given the weaker USDMYR assumption of 4.15 (previously 4.10). As for 2020, we also cut our CPO ASP forecast by -8% to MYR2,300/t (previously MYR2,500/t). Based on our revised FX assumption of USDMYR 4.15 for 2020, our revised CPO ASP forecast of MYR2,300/t translates into USD554/t (previously USD610/t; -9.2%).
• Our anticipated CPO price recovery in 2H19 and 2020 is premised on:
  1. Strong likelihood of slowing FFB output growth from 2Q19 onwards (especially in Indonesia) after two years of good harvest in 2017 and 2018 as palm trees are likely to enter into their biological rest. The depressed CPO price since 2H18 may have also led smallholders to cut back on fertilizer application. The shrinking supply of palm oil will be positive on prices.
  2. Narrowing price gap between CPO and other competing vegetable oils such as soybean oil and rapeseed oil. The price discount between palm oil and Germany’s rapeseed oil is unusually large at USD434/t (8-year historical average: USD276/t) or ~46% (8-year historical average: ~26%). Likewise, palm oil price (in Rotterdam) is at a wide discount to Argentina soybean oil (in Rotterdam) at USD238/t (10-year historical avg: USD163/t) or 32% (historically at 17%). We believe the price gap will narrow, and that the CPO price will move up as the palm oil stockpile is less burdensome now.
  3. The futures market continues to price in a recovery in CPO price, anticipating improving fundamentals in the coming months. This is reflected in the futures curve, which is in contango, with the 3M & 12M futures trading at a ~MYR54 & MYR399/t (as at 26 June 2019) premium to CPO spot price.

… and to MYR2,400/t (-150/t) for 2021

• Likewise, we also cut our 2021 CPO ASP forecast by -5.9% to MYR2,400/t (from MYR2,550/t). We believe 2021’s CPO ASP should remain on an uptrend from 2020 as the region’s production growth should decelerate further on
  1. the lack of new oil palm planting in recent years following from Indonesia’s forest moratorium and more stringent new planting requirements, and the less attractive returns of palm oil investment compared to 8-9 years ago, and
  2. the need to do more aggressive replanting in both Malaysia and Indonesia as an increasingly larger portion of the trees is simply too old.

Also, revising earnings forecasts for our stock 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. In general, purer upstream planters and companies with relatively higher cost of production will experience higher earnings cuts.

Strategy for 2H19 & 2020

• 2019 is likely to be a washout year in terms of earnings driven by the low CPO price on huge supply of palm oil that hit the market all at one go since 2H18. But this will soon pass as the supply slowdown is likely to hit the market in the coming 12-18 months. Investors should position for a price recovery during this down-cycle. While the share prices of large cap planters in Malaysia have remained relatively resilient throughout this down-cycle, the small-mid caps have not. We advocate accumulation of bombed-out small-mid caps during this down-cycle in anticipation of stronger CPO price recovery in 2020-21.
• A number of small-mid caps are trading at or near multi-year lows. For some, their PBV are even lower than the GFC trough PBV valuation. In our coverage, we like Ta Ann (TAH MK, BUY) and Sarawak Oil Palms (SOP MK, BUY) as they trade below their replacement costs on an adjusted EV/planted ha, and also near or below their GFC trough PBV valuation. For the larger caps in the region, we like FIRST RESOURCES LIMITED (SGX:EB5) and BUMITAMA AGRI LTD. (SGX:P8Z) for their relatively younger tree profiles and lower cost of production in the region.
• Our fundamental sector weight remains a NEUTRAL as sector valuation remains fair.
• See company report:
  • First Resources - Maybank Kim Eng 2019-06-28: Still A Safer Bet
  • Bumitama Agri - Maybank Kim Eng 2019-06-28: Low Cost Structure Buffers Downside

Ong Chee Ting CA Maybank Kim Eng Research | https://www.maybank-ke.com.sg/ 2019-06-28

SGX Stock Analyst Report BUY MAINTAIN BUY 1.930 SAME 1.930

BUY MAINTAIN BUY 1.01 UP 0.970