Kenanga Research & Investment

Plantation - Mixed Fortunes Among Upstream, Downstream

kiasutrader
Publish date: Thu, 11 Jul 2024, 09:58 AM

We expect CPO prices to stay firm, averaging at RM3,800 per MT in CY24 as supply increment trails demand growth. We expect better upstream profits on firm CPO prices and easier cost but weak downstream profits to persist on competition arising from excess refining capacity in the region and subdued demand for oleochemicals on a soft global economy (with the exception of the edible specialty fats). The sector’s valuations are not excessive at 1.1x PBV and 16x PER. We maintain NEUTRAL for the sector with preference for smaller, high-growth and upstream-centric planters.

CPO prices should continue to stay firm. We expect CPO prices to stay firm, averaging at RM3,800 per MT in CY24 as supply increment trails demand growth. Globally, edible oil prices often inch up (on 20-year basis) or soften (on 10-year basis) by 1-2% QoQ between 1Q and 2Q. However, price trend for different oil type varies due to different buying and harvesting cycles. Palm oil prices, for example, normally firm up in 1Q then ease QoQ till 3Q which is often the weakest quarter for prices but the best for palm oil production. For 2Q of CY24, instead of softening slightly, CPO price inched up 1% QoQ on tighter though still manageable inventory outlook. Nevertheless, 3Q CPO prices should dip as South American soyabean harvest comes to an end. Likewise, we continue to expect inventory easing further in CY25. The latest USDA as well as Oilworld’s crop forecasts for CY25 also suggests edible oil production to match or continue to trail demand growth yet again. All in all, CY24-25 inventories look adequate but the tightening trend is supportive of CPO prices.

Upstream margin is improving as energy and fertiliser prices have softened by 15%-35% YoY. Many planters are also enjoying higher palm kernel (PK) prices further helping to contain CPO cost as PK is obtained when milling FFB to extract CPO. However, pressure for higher wages is high but should stay manageable over CY24-25. Given flattish CPO price outlook and easier production cost, upstream margins should inch up 1%-3% over CY24-25.

Downstream margins likely to stay weak. Some oleo-chemical re-stocking is probably ongoing but demand remains soft, reflecting muted global economic growth as US is expected to slow down while Europe recovers and China staying flattish. Refining margins are not expected to recover soon due to excess capacity in the region as Indonesia is promoting the integration of the country oil palm sector with its own downstream capability.

New businesses are emerging but no meaningful contributions as yet. The sector has evolved in the last century from rubber to oil palm along with various adjacent trading, logistics and downstream activities. By the 1980s, property grew to become a major contributor until some spin off to operate entirely independently. Over the past year, larger players have started venturing into new businesses again.

  • IOI (MP; TP: RM3.80). In July 2023, IOI Palm Wood started marketing its panels made from oil palm trunk and in April this year IOI partnered with Nextgreen Global Bhd (Not Rated) and China’s Xiamen C&D Corp to scale up pulp and paper made using Empty Fruit Bunches with the 100,000MT plant to start in CY26/27.
  • KLK (MP; TP: RM21.00). In mid-June, the group bought the remaining 40% it does not own in a 2,500-acre plot located in southern Johor from partner, UEM Sunrise. With full control over the land today, KLK now have greater flexible over the future use of the land, be it for industrial, solar or mix development.
  • SDG (MP; TP: RM4.00). Already planned by the group is the co-development of a 1,000-acre green industrial park in Kerian, north Perak supported by a solar farm. SDG is also hopeful to participate in some solar projects under LSS 5. Altogether, the group is eager to grow its renewable footprint, from capturing palm oil mill biogas to solar.

Maintain NEUTRAL on inelastic palm oil demand, asset-rich sector with undemanding rating but upside is limited for now. Although the plantation sector’s earnings can be volatile due to CPO prices, palm oil demand is actually essential in the global food and biofuel chains. Upstream operations is generally very cash generative, gearing is manageable with many operating out of valuable landbank. The sector’s valuations are not excessive at 1.1x PBV and 16x PER. The sector is also Shariah compliant but CPO prices are likely to stay flat hence there is no compelling upside catalyst for the next quarter or two.

Within the sector, we prefer growth over yields and upstream centric players facing easing margin pressures, hence, we pick PPB (OP; TP: RM17.50) for earnings recovery over FY24-25F and exposure into China, India and SE Asia consumer essential food sector, TSH (OP; TP: RM1.30) is busy preparing to expand 25-30% of new planting over the coming 2-3 years, and UMCCA (OP; TP: RM6.00) for its maturing Indonesian estates.

Source: Kenanga Research - 11 Jul 2024

Related Stocks
Market Buzz
Discussions
Be the first to like this. Showing 0 of 0 comments

Post a Comment