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Thursday, 11 June 2015

SECTOR UPDATE

MARKET WEIGHT

Plantation – Malaysia

(Maintained)

Inventory Increases Against Expectations Of A Decline Despite strong palm oil exports, rising palm oil imports for domestic refining operations led to palm oil inventory increasing to 2.24m tonnes in May (against market expectations of a decline). The exceptionally strong export growth of 37.3% mom in May is unlikely to be repeated in June. CPO production could have also reached a mini peak in May as production may slow down due to less harvesting activity during the fasting month starting mid-June. Maintain MARKET WEIGHT. WHAT’S NEW  Inventory level at another high. Despite strong export growth of 37.3% mom (+14.7% yoy), palm oil inventory increased 2.5% mom (+21.9% yoy) to 2.24m tonnes vs market expectations of a lower inventory of 2.1m tonnes. The higher inventory was mainly due to the increase in palm oil imports (+55.5% mom, +99.4% yoy) for refining operations.  CPO production may slow down in June and July. While production is expected to continue to pick up as we enter the high production season in 2H15, it may experience some slowdown in Jun-Jul 15 during the fasting month starting mid-June and Hari Raya Puasa in July due to less harvesting rounds and days. Besides, Sabah has been experiencing dry weather since Feb 15. The prolonged dry weather is likely to have a lagged impact on production in 4Q15 and 2016. Also, the dryness impact from El Nino is expected to hit during Sep 15-Feb 16 and this would severely impact FFB yield and production growth.  Moderate growth in exports going forward. While demand for palm oil is likely to be better going into the festive season, we do not expect the strong growth in exports in May to continue in the coming months. The strong export growth in May was mainly due to deferment of shipments to take advantage of the zero export tax rate in May vs a 4.5% export tax rate imposed in Apr 15. According to Intertek, palm oil exports grew 2.2% mom to 468,975 tonnes in the first 10 days in June. ACTION  Maintain MARKET WEIGHT. CPO prices are likely to stabilise at the current RM2,1002,300/tonne pending the implementation of Indonesia’s new export levy, biodiesel blending and the development of El Nino.  Sector re-rating in the event of a strong El Nino. If El Nino turns out to be strong, the sector will be re-rated to 1SD above its valuation. In this situation, Genting Plantations and Sarawak Oil Palms have the highest upside based on re-rated valuations. On the other hand, share prices of IOI Corporation and IJM Plantations have the highest beta to CPO prices. As Sime is facing challenges in its other businesses, this may cap its attractiveness in this cycle. ESSENTIALS  Mini peak in CPO production. CPO production in May 15 was 1.81m tonnes (+6.9% mom, +9.3% yoy) vs market expectations of 1.78m tonnes. Production growth was mainly supported by the yield recovery. Sabah recorded production growth of 11.5% mom (+0.9% yoy) followed by Sarawak (+8.1% mom, +13.0% yoy) and Peninsular Malaysia (+4.2% mom, +13.2% yoy). Nevertheless, 5M15 CPO production was still down 2.8% yoy as production in 1Q15 was affected by lagged impact from the dry weather in 1Q14 and impact from the monsoon floods. Production in Sabah is likely to remain high until Sep 15 but expect a decline in 4Q15 due to the dryness experienced in Mar-May 15. The dryness also induces the ripening of fruits much earlier than usual, thus bringing forward the harvesting.

SECTOR CALL Country

Recommendation

Regional MARKET WEIGHT Malaysia MARKET WEIGHT Singapore OVERWEIGHT Indonesia MARKET WEIGHT Source: UOB Kay Hian

MPOB DATA (m tonnes) CPO Production Palm Oil Stocks Palm Oil Exports CPO Price (RM/ton) Source: MPOB

Mar 15 1.49 1.87 1.18 2,240

Apr 15 1.69 2.19 1.18 2,160

May 15 1.81 2.24 1.61 2,162

SECTOR PE HIGHLY CORRELATED TO CPO PRICES (x) 22

Regional Plantation Sector Forward PE

(US/tonne) 1,400

2sd = 20x

20 1sd = 18x

18 16

1,200

PE (LHS)

mean = 15x

1,000

14 800

12 - 1sd = 12x

10

600

- 2sd = 9x

8

CPO Price (RHS) 400

6 09

10

11

12

13

14

15

Source: Bloomberg, UOB Kay Hian

POTENTIAL UPSIDE IF SECTOR IS RERATED Company SOP GENP SIME KLK IOI IJMP Source: UOB Kay Hian

Share Price (RM) 4.64 9.92 8.53 21.50 4.03 3.61

Rerated TP (RM) 5.86 12.31 9.92 23.97 4.37 3.43

Upside (%) 26.3 24.1 16.3 11.5 8.4 (5.1)

ANALYSTS Malaysia Research Team +63 2147 1988 [email protected] Chan Yuan She +603 2147 1995 [email protected]

PEER COMPARISON Company IOI Corporation Kuala Lumpur Kepong Genting Plantations Sarawak Oil Palm Sime Darby IJM Plantations Felda Global#

Ticker IOI MK KLK MK GENP MK SOP MK SIME MK IJMP MK FGV MK

Rec HOLD HOLD HOLD HOLD SELL SELL NR

Price @ 10 Jun 15 (RM) 4.03 21.50 9.92 4.64 8.53 3.61 1.92

Target Price (RM) 4.00 20.20 9.55 4.80 8.00 2.70 n.a.

Market Cap (US$m) 6,836 6,131 2,056 547 14,188 851 1,877

2014 (x) 18.0 23.2 19.8 18.4 16.4 22.4 21.6

------ PE -----2015F (x) 25.0 23.8 25.1 14.5 30.9 26.9 23.4

2016F (x) 18.7 22.3 20.8 13.1 20.4 25.3 17.9

ROE (%) 34.3 13.0 10.3 9.0 11.8 6.0 5.0

P/B (x) 4.2 3.0 1.9 1.5 1.8 1.8 1.1

Div (sen) 8.5 54.2 7.9 6.0 36.0 7.3 5.8

Div Yield (%) 2.1 2.5 0.8 1.3 4.2 2.0 3.0

# Based on consensus Source: UOB Kay Hian

Refer to last page for important disclosures.

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 Exports jumped in May 15. Palm oil exports soared 37.3% mom (+14.7% yoy) to 1.61m tonnes in May, slightly below market expectations of 1.67m tonnes. CPO exports were 523,449 tonnes (Apr 15: 86,390 tonnes) in May while exports of processed palm was flat at 1.09m tonnes. Exports to India jumped by 4x mom to 342,859 tonnes due to the low base in April on deferment of shipments while exports to EU doubled mom. China’s palm oil intake increased 36.9% mom and 63.0% yoy. Nevertheless, 5M15 exports were still down by 8.0% yoy with low exports to China (-15.2% yoy), Pakistan (-22.8% yoy) and the EU (-12.4% yoy) despite strong growth from India (+21.2% yoy).  Marginal impact with B10 implementation. Malaysia plans to raise its biodiesel mandate to 10% by Oct 15 from 7% currently. The 10% biodiesel blending (B10) could potentially consume up to 1.2m tonnes p.a. (6% of total production in 2014 or 53% of May 15 inventory), an increase from the 0.7m-0.84m tonnes p.a. under B7. However, the implementation has been slow despite the availability of blending facilities. We believe the rollout of B10 in Malaysia will have marginal impact on CPO prices, given that Malaysia’s biodiesel blending volume is not as significant as that in Indonesia. Malaysia consumed only about 12m tonnes of diesel per year vs Indonesia’s 30m-32m tonnes.  Potentially a strong El Nino. In the past three months, the Southern Oscillation Index (SOI) has averaged −9.7, exceeding El Nino thresholds. However, the severity of the event has yet to be confirmed. In the latest Australian Bureau of Meteorology report, it indicated that the El Nino developing in the Pacific keeps sending signs reminiscent of the most severe event in 1997-98. If El Nino turns out to be a strong event similar to 199798’s, we would expect a sharp decline in FFB yield and a rally in CPO prices. The strong El Nino in 1997-98 resulted in an 8% yoy drop in Malaysia’s CPO production and a 75% yoy jump in CPO prices. We have yet to factor in the El Nino impact in our CPO price assumptions.

MINI PEAK IN MAY 15 (m tonnes)

Malaysian Monthly CPO Production

2.2 2.0

2014

2015

2013

2012

1.8 1.6 1.4 1.2 1.0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Source: MPOB

INVENTORY STAYS HIGH (m tonnes)

Malaysian Palm Oil Inventory

2.8 2.6

2014

2015

2013

2012

2.4 2.2 2.0 1.8 1.6 1.4 1.2 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

SECTOR CATALYSTS  Crude oil prices. The return of non-mandated biodiesel demand if crude oil prices recover above US$80/bbl.  Possibility of El Nino. El Nino conditions will lead to a severe drought in Southeast Asia. Dry conditions have been observed in many parts of Malaysia and Indonesia since Feb 15 but it is still too early to deduce the impact on production. The situation must be monitored closely and if El Nino conditions occur, the sector’s production will deteriorate in 2016.

Source: MPOB

JUMP IN EXPORTS (m tonnes)

Malaysian Monthly Palm Oil Exports

2.0 2014 2013

1.8

2015 2012

1.6 1.4

ASSUMPTION CHANGES

1.2

 CPO price assumptions of RM2,200/tonne for 2015 and RM2,300/tonne for 2016. RISKS

0.8

 Backtracking of biodiesel mandates in Indonesia and Malaysia on lower crude oil prices.

DOUBLE-DIGIT GROWTH IN EXPORTS

BETTER MOM GROWTH BUT 5M15 CPO PRODUCTION STILL DOWN YOY (‘000 tonnes) Malaysia P. Msia Sabah Sarawak

May 15 1,811 973 531 307

mom % chg 6.9 4.2 11.5 8.1

yoy % chg 9.3 13.2 0.9 13.0

5M15 7,282 3,905 2,139 1,237

yoy % chg (2.8) 1.3 (10.6) (0.8)

Source: MPOB

IMPACT OF EL NINO ON MALAYSIAN CPO PRODUCTION AND PRICES 91 94 98 02 07 10

El Nino Moderate to Strong Weak Very Strong Weak to Moderate Weak Moderate

FFB Yield (yoy % chg) (3.7) (9.1) (16.3) (6.1) (2.9) (6.1)

CPO Production (yoy % chg) 0.8 (2.5) (8.3) 0.9 (0.4) (3.3)

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Source: MPOB

 Another year of bumper soybean crops from the US.

Year

1.0

CPO Price (RM/tonne) 836.5 1,283.5 2,377.5 1,363.5 2,530.5 2,704.5

CPO Price (yoy % chg) 19.4 44.2 75.1 52.4 67.5 20.5

(‘000 tonnes) Total India EU China Pakistan US Japan Others Source: MPOB

May 15 1,614 343 267 360 58 45 61 479

mom % chg 37.3 292.3 104.8 36.9 (9.6) (41.3) 45.0 (6.2)

yoy % chg 13.9 32.8 21.3 63.3 (22.6) (29.6) 90.7 (12.3)

5M15 6,117 1,110 801 1,036 272 289 219 2,389

yoy % chg (8.0) 21.2 (12.4) (15.2) (22.8) (12.9) 6.9 (11.8)

Source: MPOB

Refer to last page for important disclosures.

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