Friday, September 2, 2011

Underweight on plantations

KUALA LUMPUR: UOB Kay Hian Malaysia Research is maintaining is Underweight stance on the PLANTATION [] sector and keeping its net profit forecasts and 2011-2012 crude palm oil (CPO) average selling price (ASP) assumptions of RM2,900 a tonne (US$980) and RM2,700 (US$900) respectively.

It said on Friday, Sept 2 that the sector catalyst would be an ufavourable weather which would impact the production of oil crops and palm oil.

However, the risks included a potential new plantation export tax structure in Indonesia that would negatively affect the margin for Malaysia-based refineries while a slowdown in global economy might affect demand for CPO products. Another factor would the weather's impact on global oilseed production.

In its comments on the plantations sector, it said the April to June 2011 quarterly results were mostly in line with expectations, with the exception of Sime Darby.

UOB Kay Hian Research said Sime Darby posted stronger-than-expected results on the back of strong performance from its motor and industrial divisions, and this was coupled with improved margins from its plantation division on better cost control.

'Overall, 2Q11 results posted strong year-on-year growth due to strong fresh fruit bunches (FFB) production and high CPO selling price, with the exception of IOI Corporation which posted lower earnings year-on-year on the back of weaker contribution from its resource-based manufacturing segment (-54.1% on-quarter, -37.6% on-year) that was suffering from lower sales and lower margins.

However, the downstream business posted negative on-quarter growth for all companies

The research house, in maintaining its Underweight recommendation on the sector, said it was'' less bearish on CPO price but the decreasing CPO price trend might stretch into 1Q12 on the back of high inventory level as demand is unable to catch up with the strong supply.

UOB Kay Hian Research said its top sell was IJM Plantations (Target: RM2.30) given its high valuation. Its only Buy for this sector in Malaysia was Sime Darby (Target: RM10.40) for its turnaround in operations leading to stable earnings growth. A potential catalyst could come from potential enhancement M&A domestically and globally.

To recap, it said all plantation companies recorded stronger fresh fruit bunches (FFB) production in 2Q11 due to strong yield recovery in Malaysia and high ASP. Strong yield recovery in Malaysia especially in Sabah and Sarawak has enhanced production in Sabah estates.

However, it raised concerns about the lower margin and lower sales for the downstream segments.

Companies such as IOI Crop, Kuala Lumpur Kepong and Sime Darby recorded weaker on-quarter profit for their downstream business.

This might due to: a) limited ability to pass down earlier high raw material costs that resulted from the sharp correction in CPO price in the last two weeks of June 2011, and b) thin or negative refining margins due to the sharp fall in RBD palm stearin price.

In its assessments of Sime Darby and IJM Plantations were the top performers in 2Q11. IJM Plantation benefitted from the strong yield recovery in Sabah and its active forward selling policy which enabled it to lock in higher prices.

Sime Darby's performance was boosted by the better-than-expected growth in its plantation (+88.4% on-quarter , +221.8% on-year), industrial (+52.4% on-quarter, +69.9% on-year) and motor (+16.9% on-quarter +31.4% on-year) divisions.

UOB Kay Hian Research said IOI Corporation was the weakest performer. It recorded a negative on-quarter growth of 16.6% and flat on-year net profit growth in 2Q11. This was mainly due to the lower contribution from its downstream business which were affected by the lower sales and margins across all segments.

Meanwhile, it upgraded Sime Darby from a Hold to Buy with a higher target price of RM10.40 from RM9.75 based on sum-of-the-parts (SOTP).

'We have raised our earnings forecasts for FY12 and FY13 by 6.5% and 9.3% respectively to factor in the stronger-than-expected performance for its industrial and motor divisions,' it said.

As for IJM Plantations, it cut the target price to RM2.30 to factor in the higher interest expense. This is caused by its debt funding for the new planting investment of RM600 million in Indonesia over the next four years, which offsets its upward revision of FFB production growth to 6%-7% on-year from 5%.

On the outlook for CPO, it said the CPO prices were expected to be stable in 3Q11 due to the slowdown in production as a result of less harvesting days during the Hari Raya festive holidays and biological effect after the strong production in 2Q11. Also, demand for palm oil products from China and energy producers in Europe would remain strong in 3Q11 before entering the cooler weather season in 4Q11.

However, it said a delay in the next peak production season to 4Q11 which also coincides with the low demand season could result in a further decline in CPO prices as they react negatively to rising inventory level.

On the weather, it raised concerns that excessive rainfall in 1H11 might affect the pollination in 2H11. For instance, Sabah received higher-than-average rainfall from January to April.

While sufficient rainfall was important for palm oil productivity, excessive rainfall could also affect the pollination and fruits, and hence affect the FFB production in Sabah estates, it said.

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