Sarawak Oil Palms (SOP MK, NEUTRAL, FV RM7.24, Last Close: RM6.66)

SOP’s  1QFY12 earnings were hampered on multiple fronts as weaker y-o-y CPO prices, lower sales volume and higher fertilizer application depressed revenue and elevated cost. FFB production also slowed despite the benign weather as the early-2010 drought made its  final  impact on production. We, however, do  see glimpses of hope for earnings once the drought effect subsides, the refinery capacity backlog reverses, and fertilizer application moderates.  Despite  cutting FY12 earnings  by 5.8%, our FV is raised to RM7.24  as we increase our earnings multiple to 13x from 12x FY12 PER relative to our 16x industry benchmark. Maintain NEUTRAL.

Below estimates. SOP posted 1QFY12 revenue of RM228.8m (-4.1% y-o-y on lower sales volume and weaker palm  oil  prices,  though boosted  by RM34.6m from trading activities, without which revenue would have declined 18.6%). Earnings dropped 26.5% after realized CPO prices fell by 11.0% and fertilizer cost increased due to higher fertilizer application. Although realized prices rose 10.0% q-o-q, earnings still declined 8.3% sequentially, following poorer FFB production. The quarter’s RM39.7m earnings represents just 15.5% and 18.3% of our and consensus forecasts respectively.

FFB production growth slows to <10%. SOP produced 163.2k tonnes of FFB in the first three months of the year, higher by 7.7% y-o-y. The milder production figures likely stem from the drought suffered in the region during early-2010, thus affecting production from Feb-May 2012. Production predictably fell q-o-q after entering a seasonal downcycle, although the drop was especially sharp this time around (-24.8% q-o-q compared to  -12.4% q-o-q in 1Q2011). We are maintaining our 16.1% FFB production growth forecast for 2012 on the back of a strong production rebound once the drought effect subsides. We understand that  the  weather has actually been near perfect for SOP’s FFB producing regions in northern Sarawak. 

Refinery capacity backlog continues. The refinery capacity shortage  in Sarawak experienced in 4Q2011 prolonged into this quarter, with some CPO production sold but still unshipped at the end of March. The sluggish CPO uptake by local refineries actually worsened in 1Q due to challenging downstream margins and thus, leading to a 10,945-tonne increase in SOP’s palm products inventory balance to 38,194 tonnes. This, together with a need to build inventory for its  own  refinery, explains why CPO sales volume fell y-o-y despite the stronger production volume. With the refinery beginning operations on 10 May and  coming on-stream fully in June, the inventory buildup attributed to the slow uptake by other refineries should disappear, hence suggesting a rosier 2Q. Having that said, the operating environment for Malaysian refineries remains grim and hiccups along the way would not be surprising since SOP is operating its first ever refinery.

Source: OSK188