The plantation sector ended CY23 on a muted tone. None of the big three integrated players – SIMEPLNT, IOI and KLK - met our forecasts as their downstream earnings disappointed. Looking ahead, we expect upstream to remain the key earnings driver for CY24 with downstream potentially contributing more meaningfully in CY25. Maintain NEUTRAL as the sector is supported by a PBV of only 1.2x but argument for a strong upside catalyst is still not compelling. We continue to like those with ability or flexibility to expand such as PPB (OP; TP: RM18.50) and TSH (OP; TP: RM1.30).

CY23 ended on a muted note. Plantation sector closed CY23 with a weak 4Q reporting season. No planter managed to exceed market expectations. All the three large integrated players – IOI (MP; TP: RM3.80), KLK (MP; TP: RM23.00) and SIMEPLNT (MP; TP: RM4.00) – also came below our forecasts. Downstream was the major culprit as operations encountered major headwinds such as: refining margins tightened on stiff Indonesian competition, oleochemical demand faced recessionary pressures in Europe, inflation in US and slow spending in China, while specialty fats sales proved more resilient. As such, among the larger groups, only PPB stood out and met both Kenanga and market’s expectations as it focuses more on food essentials, such as branded cooking oil to convenient ready-to-eat bread or frozen food. Profits of smaller and mid-sized planters were also better with the majority meeting or surpassing expectations from their more upstream-focused operations.

Valuation rose slightly. Despite the muted 4Q results performance, YTD, Bursa Malaysia Plantation Index (BMPI) has risen 3% above the level in 4QCY23. This is very much still within the sector’s “seasonal” range as, historically, the BMPI tends to be firmer in the 1Q and softer in 3Q, reflecting underlying palm oil price movements. On a 10-year average basis, the BMPI in 1Q is 4% higher QoQ. Broadly, the BMPI movement within a calendar year reflect to some extent the palm oil price trend.

Globally, edible oil prices tend to be firmer in 1H and weaker in 2H. Prices are often at their weakest in 3Q due to peak harvests from the four main oil crops - palm, soya, rapeseed and sunflower. Among these crops, prices of soya bean oil face less volatility - probably due to the crop having the benefits of two big quarterly harvests - 2Q in the northern hemisphere (e.g. US) and 3Q in the southern hemisphere (e.g. Brazil). Palm oil, on the other hand, often suffers more pronounced price swings. Not only does palm oil production peaks in 3Q but it is also the most widely traded edible oil, hence prices can be affected by external events, from geopolitical tension to shipping disruption or weather uncertainties affecting even other oil crops.

Oleochemical demand visibility is still clouded. After a poor 4Q, the outlook for downstream is still clouded with headwinds abating at best but no signs of any helpful tailwind thus far. The refining segment is set to stay intensely competitive due to overcapacity and input price advantages for Indonesian players. The specialty oils and fats segment is more resilient, growing at about 3%-4% YoY but some players such Bunge Loders Crooklan of IOI are gaining market shares. On the oleochemicals front, the segment is facing soft demand due to over ordering in 2021-22 and sluggish economic growth for Europe, US and China. Some re-stocking is expected later in CY24 or CY25 but margins for basic oleo-chemicals are still expected to stay weak while specialty oleochemicals should continue to enjoy decent profits on much smaller volume though.

Upstream to stay the key earnings driver as margins should improve over CY24-25 on firm CPO prices and abating cost pressures:

a) Firm CPO prices. Global balance of edible oil is expected to stay tight in CY24, potentially up to mid-CY25. Supply is expected to just about meet CY24 demand with risk of even coming short. As a result, CY25 is expected to begin the year with lower YoY inventory levels or flattish at best, hence firm CPO price of RM3,800 per MT is expected.

b) Production cost should ease as global fertiliser and fuel costs have been trending down.

c) Palm kernel (PK) prices may be bottoming. If restocking orders do indeed materialise from the oleochemicals segment, PK prices may start inching up which in turn will help contain CPO costs further as PK is a by-product of milling FFB to extract CPO.

Defensive. Amidst near-term CPO price and thus earnings volatility, longer term, the plantation sector can be defensive as (i) palm oil is largely (70%) consumed as food despite growing use as bio-fuel, hence demand growth is quite steady, (ii) most upstream operations are also strong cash generator, hence (iii) gearing levels are generally decent, from manageable borrowings to surplus cash. Moreover, the value of agriculture land, especially those along the west coast of Peninsular Malaysia, are often significantly higher than what is being carried in their balance sheets.

Maintain NEUTRAL. Trading at PBV of 1.2x, the price downside of planters is probably limited but near-term upside catalyst is not compelling. Higher CPO prices would be such a catalyst and such a possibility cannot be ruled out in light of prospective supply tightness. However, (a) the downstream is likely to remain a drag to the earnings of larger integrated players for another quarter or two, and (b) the prospects of supply staying fragile is probably already priced in the share prices being old news. All in all, we maintain our NEUTRAL stance for the sector as well as preference for planters with the ability, capability and/or appetite to grow their business beyond just earnings recovery from an upswing in palm oil prices. As such, we like PPB for its agri-business positioning and TSH for its development to plant another 8k-10k Ha of oil palm (25%-30% expansion) over the coming 2-3 years.

Source: Kenanga Research - 7 Mar 2024