Plantation Sector

What’s New

Malaysian Palm Oil Board (MPOB) released palm oil statistics for June 2012.
We upgrade the sector to Overweight in view of positive catalysts such as: a) tight global palm oil supply, b) possible of El-Nino in 2H12 and c) low soybean production.

Comment

CPO production growth decelerated in June. CPO production grew at a slower pace of 6.3% in June after recorded 8.73% growth in May. However, CPO production in June shed 16% y-o-y owing to the bumper harvest in 2011. We reckon positive CPO production growth momentum could persist upon entering 3Q12 and continue to grow at the range of 4-7% in July.
Tight global palm oil supply. CPO production in Malaysia for the first half of 2012 eased 9.1% y-o-y to 7.8 mil tonnes caused by high base effect in 2011 (8.6mil tonnes) and tress stress issue in 1H12. We reckon issue of tree stress could be further stretched into 2H12 and production growth could be under pressure to meet the industry forecast of 0-4% in 2012. Likewise, CPO production growth in Indonesia is widely expected to grow moderately at 4-7% in 2012 after posted robust growth of 12% in 2011 mainly attributable to the slower planting activity in 2008/2009. We believe tight global palm oil supply would continue support CPO prices in 2H12.
Resilient palm oil demand. Palm oil export remains resilient in June by registering a robust growth of 8.7% following 4.8% growth in May. Stronger export growth in June was mainly driven by the stronger palm oil demand by the major palm oil importers, which are China (+38.2% m-o-m), Pakistan (+15.4% m-o-m), India (+34.1%), and United States (+27% m-o-m). Strong export demand in June was primarily driven by the last minute buying spree leading up to the Muslim’s fasting month starting July. We also believe strong export demand by China was attributable to the stronger palm oil demand ahead of Mid Autumn Festival in September. Meanwhile, palm oil export to European countries eased 23.1% m-o-m in June after posted 10.6% growth in May. Moving forward, we expect palm oil export to remain resilient in July.

Palm oil closing stocks running low. Palm oil closing stock continued to ease in June, recorded 1.7mil tonnes stockpiles. Palm oil closing stocks ran down for four consecutive months since March, marked its 14-months low, matching its stronger export demand in the corresponding period. Moreover, we believe low palm oil stockpiles were attributable to softer year-to-date CPO production. With the palm oil stockpiles running low, we believe it should well support CPO prices in the next coming months.
Soybean production crimped by unfavorable weather. We expect soybean production in 2H12 will be crimped by the extreme hot and dry weather in US Midwest where dry weather could damage soybean crops and impede the planting of the last of the soybean crop. Likewise, US Department of Agriculture (USDA) slashed its condition rating on soybean crop by 8% to 45% good-to-excellent, reflecting the potential jeopardy of tight soybean supply. Meanwhile, US Climate Prediction Center stated higher chances of El Nino occurrence beginning in July-September. We reckon tighter soybean oil supply would emerge should the El-Nino materializes and more demand is expected to shift to palm oil and eventually lift CPO prices.
2H2012 CPO production further dent by El-Nino. The latest 30-day Southern Oscillation Index (SOI) value was –11.8 where value below –8.0 typically indicates an El-Nino event which would cause droughts in Malaysia and Indonesia. We reckon droughts would adversely impact the CPO yield and aggravate the already soften CPO production in 2H12. Thus, we expect CPO price could surge in 2H12 should the El-Nino turns out to be worse than expected.
Average CPO price in June was RM2956/tonne, tumbled 7.3% m-o-m. CPO price continued to decline in June by 7.3% after slid 8.4% in May. Following the CPO price inched up 9.4% in the first four months, CPO price started to retreat in May and June mainly owing to the sluggish outlook of CPO demand amid the weak global economy backdrop. Average CPO price in 1H12 was RM3200/tonne, in line with our CPO assumption for the year of RM3200/tonne. Hence, we maintain our CPO price assumption for 2012 despite the recent sharp decline of CPO price, pinning hopes on the plantation sector to stage a rebound in 2H2012.
Sector close to bottom and set to rebound in 2H12. We think the cycle of sector has bottomed and set to rebound in 2H12, partly hinges on possible further monetary stimulus to be introduced, mainly Quantitative Easing 3, which would support global commodity prices. We believe tight global palm oil supply from Malaysia and Indonesia would continue support CPO prices. Moreover, we also reckon weather risk for soybean production and El-Nino event could be the potential catalyst for the sector in 2H12.
We upgrade the sector to overweight from marketweight mainly due to tighter global palm oil supply and the higher chance of El Nino occurrence in 2H12 which outweigh the weak global economy. Moreover, we reckon the underlying demand for palm oil remains resilient, underpinned by increasing world population and the festive seasons in 2H12.

Valuation & Recommendation:

Our top pick for the sector is Kuala Lumpur Kepong, upgrade to BUY from HOLD with target price of RM26.55 (previously RM24.60), pegged at higher PE of 17.8 times FY13 EPS which is slightly above its historical PE of 17.5 times. We like KLK for its status as plantation sector bellwether with excellent tree age profile and as a proxy for CPO price upswing.
We continue favour IJM Plantations, maintain BUY with a higher target price of RM4.10 (previously RM3.50) after roll over our valuation to FY14 (pegged at 16x FY14 EPS which is above its historical mean) in view of its strong earnings contribution from Indonesian estates.
We also like IOI Corporation (Target price: RM6.12) for its undemanding valuation and its status as plantation giant.
We reckon plantations stocks shall return to investors’ radar screen as the sector is showing sign of recovery. We think it is an opportune time for investors to ride on the potential sector rebound.