Plantation – Singapore - UOB Kay Hian 2020-08-21: Expecting A Better 2H20

BUMITAMA AGRI LTD. (SGX:P8Z) GOLDEN AGRI-RESOURCES LTD (SGX:E5H) FIRST RESOURCES LIMITED (SGX:EB5)

Plantation – Singapore - Expecting A Better 2H20

Sector earnings improved y-o-y in 1H20, buoyed by higher selling prices, except for Golden Agri Resources. We expect companies to continue to deliver better h-o-h earnings in 2H20 on the back of marginal increase in production and better ASP.
With the potential changes in biodiesel prices and the export levy in Indonesia, we expect integrated players to see lesser adverse impact where the biodiesel segment would be able to cushion the impact from higher export levy.
Maintain MARKET WEIGHT.

Most companies in our universe reported better y-o-y earnings in 1H20, anchored by better selling prices despite lower sales volume and production. However, Golden Agri Resources (SGX:E5H) remained in net loss for 1H20 due to higher operating expense. See summary of 1H20 results in PDF report attached below.
On production, most companies reported lower y-o-y FFB production in 1H20 except for First Resources (SGX:EB5) which reported a marginal increase of 0.3% y-o-y in 1H20. This is mainly due to the fact that First Resources’s estates are mainly in Riau region where there was lower rainfall volume in 2Q20, while the impact from the dryness in 2019 was lesser compared with its peers.

At end-19, the market was expecting Indonesia production to increase by 1m tonnes and companies had guided for positive to flat y-o-y production growth for 2020. However, post the disappointing 1H20 production in Indonesia, companies have revised down their production growth guidance for 2020 to negative to flat y-o-y growth for 2020.
The disappointing 1H20 production in Indonesia was mainly due to the unfavourable weather and low fertiliser application in 2019. Having said that, we maintain most of our FFB production growth forecasts for the companies as we had highlighted the impact in our previous notes.

We expect companies to continue to deliver better h-o-h earnings, anchored by higher selling prices. Production in 2H20 could be marginally better than in 1H20. Companies are guiding 1H:2H production ratio at 45:55. Having said that, we expect better h-o-h sales volume in 2H20 as there was some inventory build-up towards end-Jun 20 which will be delivered in 3Q20.

With the wide price gap between biodiesel and diesel prices where the CPO fund need to incentivise since Jan 20 to-date, the market is concerned whether the CPO fund is able to continue to support the B30 biodiesel programme. However, we see strong support from the Indonesia government for the B30 biodiesel programme with supportive measures such as an increase in export levy, change in biodiesel conversion price and the injection of Rp2.78t from the government.
Further, from our channel checks, biodiesel producers do not face any issue in terms of receiving the incentive from the government.

Maintain MARKET WEGHT on the sector as we believe CPO prices may soften when CPO production starts to climb in late-Aug 20, with an expected peak in Sep-Oct 20. Furthermore, palm oil demand from China and India are expected to fall after their inventory replenishment. Plantation stocks under our coverage are not trading at depressing valuation as most are trading at +1SD above their 5-year mean PE.
From the recent analyst briefings and news, we gather there might be potential changes to further support the B30 biodiesel programme:
- Export levy. The Indonesian government might raise the palm oil export levy further. The current CPO export levy is US$55/tonne.
- Change in biodiesel prices. The biodiesel conversion cost was reduced from US$100/tonne to US$80/tonne in May 20. This might be reviewed and revised by the Indonesia government again.

If the above changes come true, it may have an adverse impact on pure upstream players such as Bumitama Agri (SGX:P8Z), mainly because upstream players need to pay higher export duty which is used to fund the cost difference between biodiesel and diesel prices as an incentive for biodiesel producers. Hence, integrated companies such as First Resources and Golden Agri Resources would see less impact on earnings as the higher cost on export duty would be partially mitigated by their biodiesel segment.

A potential La Nina in 2H20 could shift the global vegoil supply outlook but this should favour palm oil. Australia’s Bureau of Meteorology in its latest El Nino-Southern Oscillation (ENSO) Outlook update maintained La Niña WATCH or the chance of a La Niña event forming in the coming months at 70%.
Impact from delays in fertiliser application.
Higher-than-expected biodiesel usage.

Prolonged lockdown and movement control will continue to hurt demand from the HORECA sector, which is negative to palm oil prices.
Protective trade policies in importing countries could lead to lower demand for palm oil.