We maintain our Overweight stance on the sector, with unchanged 2022-23 CPO price assumptions of RM3,500/mt and RM2,900/mt, as we believe depressed valuations among plantation players have more than reflected the anticipated decline in CPO prices. Our top picks are IOI Corp (BUY; TP: RM4.35), KLK (BUY; TP: RM25.62), Sime Darby Plantation (BUY; TP: RM5.03) and TSH Resources (BUY; TP: RM1.35).

Near-term CPO price to remain elevated. We believe CPO price will remain elevated in the near term (possibly until 1Q22), supported by (i) La Niña phenomenon, which will likely affect soybean output in South America, as lack of rainfall (arising from La Niña phenomenon) will likely result in delay in soybean planting there and (ii) seasonally lower production cycle (which is expected to last until 1Q22), and this bodes well for near term CPO price. Historically, prices of CPO and soybean tend to strengthen as La Niña (as well as El Niño) sets in and weaken when the weather anomaly subsides.

CPO price to start trending down from 2Q22. We hold the view that CPO price will start trending down from 2Q22 onwards, on the back of increased optimism on major vegetable oil output prospects (including palm oil and soybean), higher inventories in major vegetable oil consuming countries (such as China and India), and palm’s narrow discount against soybean oil.

However, the pace of CPO price decline may turn out to be slower-than-expected. A more meaningful pullback in CPO price would only materialise when palm oil output recovers, which in turn hinges on several uncertainties including (i) the entrant of foreign workers into Malaysian shores, which could be delayed, as recent Omicron variant has resulted in the government tightening of existing standard operating procedures (SOPs) on the entry of foreign workers, and (ii) surging fertiliser prices, which may result in planters (in particular smallholders) reducing fertiliser application to oil palms, hence derailing the anticipated yield recovery.

Maintain 2022-23 CPO price assumptions of RM3,500/mt and RM2,900/mt. We anticipate supply of vegetable oil to remain tight for the next few months, and a more noticeably decline in CPO price would only happen when supplies of vegetable oil (in particular, palm oil and soybean) start showing signs of recovery (possibly by 2Q22).

Share price underperformance has priced in ESG concerns, we believe. The KLPLN Index fell 10.3% in 2021, underperforming the KLCI by 6.6%-pts. Against the CPO spot price, the KLPLN Index underperformed by an even bigger margin (by 45.3%- pts), and we believe this is largely due to environment, social and governance (ESG) concerns within the sector (arising from forced labour allegations on Sime Darby Plantation and FGV Holdings). We believe ESG concerns have already been reflected in the sector’s valuations, as (i) most players (particularly, larger sized players, which have been in the limelight amidst ESG issues) have been putting efforts in rectifying these issues, and (ii) foreign shareholdings are at multi-year low level.

Maintain Overweight stance. We maintain our OVERWEIGHT stance on the sector, underpinned by good near term earnings prospects (arising from high CPO prices) and commendable valuations. Top picks are IOI Corp (BUY; TP: RM4.35), KLK (BUY; TP: RM25.62), Sime Darby Plantation (BUY; TP: RM5.03), and TSH Resources (BUY; TP: RM1.35).

Source: Hong Leong Investment Bank Research - 4 Jan 2022