• The conclusion of the fourth quarter earnings reporting season lacked notable excitement, yet it proved to be favorable for the market, despite the results being mixed in comparison to our expectations.

• Overall, out of the 10 companies under our coverage, 5 met expectations, 3 exceeded them, while only 2 companies—FGV and SIME Plant—fell below our forecasts. The reported earnings were primarily attributed to improved FFB production and reduced production costs during the period, which partly offset the decrease in palm product prices for upstream business and squeezed in margin for downstream business.

• Assuming no other unexpected events, we expect the CPO price to trade within a range of RM400/MT above or below RM3,800/MT for the rest of the year. This expectation is supported by: 1) anticipated tightness in palm oil (PO) supply, coupled with the strength in other edible oil prices such as soybean oil (SBO), 2) prolonged geopolitical tensions, including the Russia-Ukraine conflict and Middle-East tension, and 3) potential increases in production costs that might surpass initial projections. However, downside risks lie in subdued demand and an unattractive PO price discount compared to other soft oils, such as the SBO price (currently at USD260/MT).

• We maintain a NEUTRAL call on the plantation sector, considering the expected risk of challenging earnings due to lower-than-expected palm product prices, muted demand, and lower-than-expected production. Additionally, we maintain the 2024 CPO average selling price (ASP) of RM3,600/MT.

Improved Production and Cost Efficiency Drive Profitability.

The fourth quarter earnings reporting season ended without much salutation, but was still market-friendly. As anticipated, core earnings for the 10 companies under our coverage saw 5 meeting expectations, 3 exceeding them, while only 2 companies— FGV and SIME Plant—fell below our forecasts (Table 3). The lower-than-expected production of palm product and higher-than-expected operating expenses were the key variances against our forecast for FGV and SIME Plant. As most of upstream segment saw improvement in earnings due to better sales and production of palm oil products and/or improved in cost efficiency, FGV plantation segment earnings were impacted by lower FFB processed, stemming from the decline in external crops, as well as lower margins resulting from decline in average CPO prices and increase in CPO cost ex-mill during the period.

On the contrary, the downstream manufacturing segment continues to struggle with squeezed margins and uncertain profit sustainability. This is attributed to reduced contributions from both the refinery and oleochemical sub-segments, stemming from negative or thin refinery margins, slower demand across both segments, and challenging operational conditions. The subdued demand was primarily influenced by intense competition from other edible oils, notably soybean oil and sunflower oil, amidst a sluggish global economy marked by high inflation. Conversely, the refinery and commodity market sub-segments persistently grapple with low or negative margins, largely due to stiff competition from Indonesian counterparts benefiting from their CPO export policy.

Earnings outlook: Prone to significant impact from shifts in production, cost factors, and fluctuations in CPO prices. We maintain a "cautiously constructive" outlook on plantation companies, while remaining vigilant about external challenges, especially during periods of lower productivity for palm oil. In our view, to sustain profitability, companies must efficiently manage operational costs and capitalize on improvements in FFB yield, given the current volatility in palm product prices. As such, it is worth considering plantation companies with the potential for higher production growth this year, such as IOI, KLK, SIME Plant, HAPL, SOP, Sarawak Plant, and Genting Plant.

Maintain CPO price range near RM3,800/MT, to trade within a range of RM400/MT above or below for the rest of the year. In the midst of industry-wide challenges, including escalating operational costs and consistently low yields, plantation companies are finding reassurance in the optimistic sentiment surrounding the current CPO price outlook, which is anticipated to offer sustained support for CPO prices. Assuming no other unexpected events, we expect the CPO price to remain within a range of RM400/MT above or below RM3,800/MT for the rest of the year. This expectation is supported by: 1) anticipated tightness in palm oil (PO) supply, coupled with the strength in other edible oil prices such as soybean oil (SBO), 2) prolonged geopolitical tensions, including the Russia-Ukraine conflict and Middle-East tension, and 3) potential increases in production costs that might surpass initial projections.

However, there are several downside risks to our CPO price outlook and as such we anticipate a moderation in CPO price, which is likely to be influenced by several factors:

1. Narrowing/negative discount gap of PO price and soybean oil price - potentially limiting PO price competitiveness and hence, leading to slowing demand from major importing countries (as time writing: USD260.11/MT; 5-years average discount: USD225.63/MT);

2. Muted Demand Amid Global Uncertainties: Additionally, there is the risk of muted demand due to global economic uncertainties, inflationary pressures, heightened price sensitivity in importing countries as well as potential geopolitical tensions risk surrounding territorial disputes from China; and

3. Strengthening of ringgit against US Dollar: this may impact export competitiveness and hence, further weigh on the demand for palm oil product.

Maintain a NEUTRAL call on the plantation sector with a 2024 CPO average selling price of RM3,600/MT, considering the anticipated risk of challenging earnings due to lower-thanexpected palm product prices, muted demand, and ongoing lower-than-expected production, which are expected to persist and pose challenges for plantation companies' prospects. We have a BUY call on IOI (TP: RM4.50) and SELL call on FGV (TP: RM1.23).
 

Source: BIMB Securities Research - 7 Mar 2024