Regional Plantations - UOB Kay Hian 2021-01-07: CPO Prices To Trade At High Levels In 1H21

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Regional Plantations - CPO Prices To Trade At High Levels In 1H21

• We raise our CPO ASP for 2021 to RM3,000/tonne from RM2,600/tonne (+15.4%). There has been a larger-than-expected increase in CPO price, and this is likely to stay firm at least in 1Q21 on the back of tight global vegoil supply. However, we maintain our view that prices may weaken as palm oil production recovers towards end-3Q21 and inventories could then start to rebuild.
• Maintain MARKET WEIGHT.
• Our picks to ride on higher CPO price are Hap Seng Plantations, Kuala Lumpur Kepong, Kim Loong Resources and Sarawak Oil Palms, Bumitama Agri (SGX:P8Z), First Resources (SGX:EB5), Astra Agro Lestari and Tunas Baru Lampung.

Revised CPO ASP for 2021 to RM3,000/tonne as current price has increased more than expected.

• CPO future contract for Jan and Feb 21 hit RM4,000/tonne yesterday, driven by stronger soyoil price and concerns of weak CPO production continuing into 1Q21. With higher-than-expected current CPO price that is likely to sustain for at least another quarter, we have thus revised up our CPO price assumption by 15.4% for 2021 to RM3,000/tonne from RM2,600/tonne.
• Factors that support the current high prices are:
  1. Malaysia palm oil inventory level is likely to have hit a 13-year low in Dec 20. Malaysia palm oil inventory level was at 1.57m tonnes in Nov 20 and is expected to have hit a 13-year low of 1.18m-1.20m tonnes by end-Dec 20. As compared to end-Dec 19, Malaysia palm oil inventory is expected to decline by 0.37m tonnes in end-Dec 20, which is one of the sharper declines on record.
  2. Palm oil supplies to stay tight in 1H21. Production in 4Q20 came in way below expectation due to lower fresh fruit bunch (FFB) yield and wet weather. Global palm oil production is expected to increase by 3.8m tonnes in 2021, mainly from Indonesia, but supplies will not increase much as end-20 stocks are significantly lower than 2019. From our channel check, the current supply situation in some estates is very tight during this rainy season and has led to low FFB yield and low oil extraction rate (OER).
  3. Tight global vegoil supply. La Nina, a drought-inducing weather phenomenon in North and South America, has negatively impacted the global vegoil supply (ie soybean, rapeseed and sunflower), and resulted in a lower global vegoil production. Market analysts have been consistently revising their soybean production estimates downwards due to the drier-than-expected weather, which has resulted in market concerns on the tight supply.

Maintain MARKET WEIGHT.

• We have revised our CPO price assumption to RM3,000/tonne for 2021, as we expect CPO prices to continue trading at high levels in 1H21 on the back of tight supply and recovery demand. Having said that, we maintain MARKET WEIGHT on regional plantation sector as we remain concerned on the strong production recovery in 2H21 and demand rationing with the high CPO prices.

Prefer companies with higher exposure in Malaysia.

• We prefer pure upstream players with only Malaysia-skewed operations, ie Hap Seng Plantations (HAPL), Sarawak Oil Palms (SOP) and Kim Loong Resources (KIML) as they would benefit more from higher selling prices vs peers with Indonesia exposure.
• Among the big caps in Malaysia, we have upgraded Kuala Lumpur Kepong (KLK) to BUY from HOLD.

Why are plantation stocks still exhibiting lukewarm performance?

• Buying interest remains sluggish mainly due to:
  1. Muted earnings. As palm prices rise, companies would need to pay more levies and duties. The Indonesia government had adopted a progressively escalating export levy in Nov 20. Further to that, companies have to also bear higher cost during this pandemic such as labour cost, logistics cost and some of the pandemic-related compliance costs.
  2. High CPO price volatility. The sustainability of high CPO prices remains a concern given the high volatility in 2020.
  3. Limited supply. Some producers may see a big drop in production, which will partially offset the impact of high CPO selling prices.
  4. Environmental, social and governance (ESG) concern, especially after the ban on FGV and Sime Darby Plantations. The plantation sector has been in the limelight due to sustainability issues, having been labelled as the main cause of deforestation and wildlife extinction, especially from the West. With the increased adoption of sustainability-focused investing, we have noticed a decline in foreign shareholdings in plantation companies recently and we believe this is mainly due to ESG issues.

Expect to see selective buying from investors.

• Lately, we have been seeing more interest from investors, and their questions mainly focus on the sustainability of CPO prices and the potential share price movement along with the climbing CPO prices. We may see some buying interest for plantation stocks as CPO prices have hit a 13-year high and companies should report good earnings again for both 4Q20 and for 1H21.
• We remain selective on stocks picks, focusing on upstream player companies, especially those with pure Malaysia exposure, while advocating BUY on Indonesia-based companies as they are still trading at attractive valuations.

Earnings upgrade for 2021.

• We raise our 2021 CPO price assumptions to RM3,000/tonne (previously RM2,600/tonne). Based on our higher CPO price assumptions, the potential sector earnings upside in 2021 will be 17%, 5% and 7% for Malaysia, Singapore and Indonesia companies respectively.
• We prefer pure upstream Malaysia players which will benefit the most from the higher CPO selling prices with the absence of the aggressive Indonesia export levy structure.

Changes in recommendations.

• We upgrade Hap Seng Plantations, Kuala Lumpur Kepong, Kim Loong Resources and Sarawak Oil Palms from HOLD to BUY with price upside of 10-20%.
• We also upgrade Genting Plantations and IJM Plantations from SELL to HOLD.

Plantation stock recommendations

Kuala Lumpur Kepong (KLK MK): BUY, Target Price: RM26.00.

• Among the Malaysia big cap companies, we prefer KLK on the back of:
  1. its undemanding valuation as compared to other big cap plantation peers;
  2. its small exposure to the rising glove demand through its associate company Synthomer (SYNT LN); and
  3. KLK is also in the midst of expanding its current glove operation into nitrile gloves.
• A new plant will be built next to its current glove plant with an annual capacity of 4.5b pieces with full capacity to come by 2023. The first production line is expected to be completed by end-21.

Hap Seng Plantations (HAPL MK): BUY, Target Price: RM2.70.

• We like HAPL as the company usually sells its products at spot prices. HAPL’s selling prices are also always higher than its Sabah peers as the former gets a price premium for its sustainability certifications.

Kim Loong Resources (KIML MK): BUY, Target Price: Target: RM1.80.

• We like KIML for its pure upstream exposure, better earnings generation from palm by-products and also its higher-than-peers dividend yield at about 6%.

Sarawak Oil Palms (SOP MK): BUY, Target Price: RM5.20.

• Among all Sarawak plantation companies, we reckon that SOP has one of the best estate management practices. SOP also has high earnings sensitivity towards high CPO prices and high beta to CPO price as well.

Bumitama Agri (SGX:P8Z): BUY, Target Price: S$0.70.

• We like Bumitama Agri (SGX:P8Z) for its high dividend about 5%. It is also trading at attractive valuation.
• See Bumitama Agri Share Price; Bumitama Agri Target Price; Bumitama Agri Analyst Reports; Bumitama Agri Dividend History; Bumitama Agri Announcements; Bumitama Agri Latest News.

First Resources (SGX:EB5): BUY, Target Price: S$1.85.

• We like First Resources (SGX:EB5) for its better-than-peers FFB production growth as most of its estates are located in the Riau region, which has seen lesser impact from the recent high rainfall. Further to that, First Resources also has higher OER compared to peers. Its downstream operation mitigates the impact from the high exports levy that takes a cut of the CPO price from upstream players.
• See First Resources Share Price; First Resources Target Price; First Resources Analyst Reports; First Resources Dividend History; First Resources Announcements; First Resources Latest News.

Astra Agro Lestari (AALI IJ): BUY, Target Price: Rp15,500.

• AALI should benefit from the recovery of palm oil production in Indonesia, which will likely translate into higher external FFB purchase and higher CPO production growth in 2021. AALI also has high beta to CPO price.

Tunas Baru Lampung (TBLA IJ): BUY, Target Price: Rp1,235.

• We like TBLA as it is the cheapest entry into the sector and its steady earnings contribution from its biodiesel and sugar segments should mitigate the volatility from CPO price.

Sector Risks

High prices come with high volatility.

• While the high CPO prices may sustain for now, we cannot overlook the volatility that arises from the high prices. The potential drawbacks are:
  1. Demand rationing. Purchasing power, especially in developing countries, may not return to pre-COVID-19 levels and this would limit consumption at current high prices. Further, the narrowing discount of CPO prices to soybean oil prices may see demand move to soybean, while palm oil may also not be able to recapture the market share that was lost to sunflower oil in early-20.
  2. Higher output in 2H21. With the higher rainfall volume in 2020 and better yield recovery from the lack of fertiliser application in 2H18 and 2019, CPO production is staging for a good recovery, especially in 4Q21. Prices will react negatively ahead of the potential inventory build-up, likely in 4Q21.
  3. Demand for vegoil as biodiesel feedstock may cool off as supply of used cooking oil (UCO) is set to increase with the reopening of the HORECA (hotel, restaurant and catering) sectors. The reopening of HORECA will increase the supply of UCO, which will see it regaining market share that was lost to palm oil and soybean oil in 2020. UCO is a more popular feedstock for biodiesel in Europe, the US and China.

Sector Catalysts

More severe damage to Brazil’s soybean production due to dry weather.

• Current weather conditions point to slower planting progress and this could delay harvesting to Feb 21. However, if the dry weather continues, this would affect the growth stage and lead to a more significant drop in yields. Brazil is currently importing US soybean due to the delay in planting. This would continue to lift global soybean prices.

Strong biodiesel demand due to recovery in crude oil prices or higher mandate from producing countries.

• Recap that in 2020, despite low crude oil prices, we saw an increase in usage of biodiesel in some countries such as Brazil, the US and Germany as companies are increasingly committed to lowering their greenhouse gas emission targets. At the peak (in 2019), palm oil usage in the energy/biodiesel sector was about 39% (2021F: 37%).

Leow Huey Chuen UOB Kay Hian Research | Jacquelyn Yow Hui Li UOB Kay Hian | https://research.uobkayhian.com/ 2021-01-07

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