Agribusiness - CGS-CIMB Research 2020-03-31: Potential Impact From Sabah Shutdown

FIRST RESOURCES LIMITED (SGX:EB5) WILMAR INTERNATIONAL LIMITED (SGX:F34)

Agribusiness - Potential Impact From Sabah Shutdown

Sabah announced that it will extend the suspension of palm oil operations by two weeks and widened the order from three districts to six.
This is negative for planters with estates in this region like Hap Seng Plantations, FGV and IOI Corp.

We estimate potential decrease in earnings may be as much as 54%. This is because the suspension for up to 21 days will significantly impact production and could aggravate the long-standing labour shortage issue.

Malaysia’s largest palm oil producing state, Sabah, announced that it will extend a shutdown of palm oil operations by two weeks from 1 to 14 Apr and widened the order to six districts.
To recap, the state last week ordered palm oil plantations and factories in three districts to close until 31 Mar after seven estate workers tested positive for Covid-19. See Agribusiness - CGS-CIMB Research 2020-03-24: Temporary Suspension Of Estates Operations In 3 Districts In Sabah Due To Covid-19.
The Sabah state government said palm plantations and factories in a total of six districts - Kalabakan, Semporna, Kunak, Tawau, Lahad Datu and Kinabatangan - must shut down until mid-Apr. "Fresh fruit bunches that have been harvested at plantations can be delivered to factories, but factories and plantations are not allowed to operate until the end of the order on 14 Apr," Sabah's chief minister, Shafie Apdal, told reporters.

This will disrupt harvesting activities and lead to a decline in FFB yields, oil extraction rate (OER) rate as well as lower quality CPO after the shutdown, from affected areas in Sabah regions. According to the Malaysian Palm Oil Association (MPOA) and Malaysia Estates Owners Association (MEOA), the orders will affect 65% of the total planted area in Sabah of 1.2m ha and 75% of palm oil production in Sabah involving c.100k workers.
The associations estimated the potential revenue loss at RM860m for a month of closure and loss of revenue to the state government from the 7.5% sales tax revenue at RM57m. Hence, they are appealing to the state government to reconsider their decision and allow estate owners to resume essential and critical operations.

This is negative for plantation companies that have exposure to these regions. We estimate the potential impact on CPO output for the two weeks of closure in Sabah is c.132k tonnes or c.9% of Malaysia’s monthly CPO output. This will likely cut the palm oil inventory figure for end-Apr and will be positive for CPO prices in the near-term, benefitting planters that are not affected by the shutdown.
The earnings of upstream palm oil producers with exposure to Sabah estates are likely to be hardest hit by this directive as estate costs are mostly fixed and the loss in revenue will mostly flow through to earnings. This will negatively impact cash flows of planters and millers and result in potential undeliverable commitments if planters sold their crops forward.
Plantation companies with significant Indonesian estates, like Sime Plantations, Kuala Lumpur Kepong, Wilmar (SGX:F34) and Genting Plantations will be partially cushioned as they may get better CPO prices for their Indonesia output.

We ran a quick sensitivity analysis on the plantation companies under our coverage, with exposure to affected areas, and found that the potential negative impact on our forecasts for net profit from estate operations (excluding milling activities) could range from RM7m to RM31m.
FGV earnings will be most sensitive to the closure due to its higher fixed costs base due to the land lease agreement (LLA) as well as lower earnings base. We estimate the closure could lower FGV’S FY20F net profit by RM33m or 54%.
Among the planters under coverage, Hap Seng Plantations will be the second worst impacted by the closure due to high concentration of estates in Sabah affected by the lockdown. We estimate the lockdown could lower its net profit by RM15m or 45%. IOI Corp and Genting Plantations will be the third and fourth worst-hit among our coverage as we estimate the disruption could reduce our earnings forecasts by 4% and 3%, respectively, in FY20F.
Our preliminary estimate reveals the potential negative earnings impact to Kuala Lumpur Kepong is 1% and Wilmar negligible. Our earnings forecasts are intact, pending the outcome from the appeal.
We stay sector Neutral and expect average CPO price of RM2,300 per tonne for 2020.

Ivy NG Lee Fang CFA CGS-CIMB Research | Nagulan RAVI CGS-CIMB Research | https://www.cgs-cimb.com 2020-03-31

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