We are upgrading the Plantation Sector to OVERWEIGHT from Neutral previously on expectation that palm oil price is on the cusp of a 3-year upcycle. The SOI’s recent plunge suggests that the El Nino weather phenomenon is imminent and may hurt palm oil production. This could be the initial catalyst for the commodity’s price rally. In longer term, the potential peaking of Indonesia’s production will sustain the price uptrend. We continue to prefer companies with younger trees, which are more resilient against adverse weather, namely SOP, BW and Kencana.
Probability of an El Nino increases. The Southern Oscillation Index (SOI) plunged to minus 11.8 recently, suggesting that there is a higher probability of an El Nino occurrence. Such a weather phenomenon typically causes drought in South-East Asia, which is a key palm oil producing region. This will curb palm oil production and stoke palm oil’s price surge. Note that the last severe drought that hit the region was six years ago in 2HCY06, during which certain parts of Indonesia did not get any rainfall for 5 to 6 months.
Malaysia production deteriorates further. Malaysia’s palm oil production for the first five months fell 7.3% due to adverse weather while May production alone sank 20.6% y-o-y. Any deterioration in weather will aggravate the already poor production, and in turn support an uptrend in palm oil price.
Raising CY13 average palm oil price. We are raising our average price assumption for CY13 to RM3,500 per tonne from RM3,100 per tonne, and accordingly, our earnings forecasts across the board. We are also incorporating a decline in production growth to factor in drought conditions. Previous peak price of RM4,500 will likely be surpassed before this upcycle is over.
North America’s soybean planting. North America’s soybean planting is not doing well due to hot and dry weather. While an El Nino usually brings on dry weather in South-East Asia but plenty of rain to North & South America, this is not happening this season. Although speculative long positions are on the high side, they may continue to stay high so long as uncertainties over North America’s soybean output continue to linger.
UPGRADE SECTOR TO OVERWEIGHT
Upcycle in the making. We are upgrading the Plantation sector to Overweight on expectation of palm oil price entering a new three-year price upcycle, fuelled by increasing probability of a drought-inducing El Nino weather phenomenon. We believe Malaysia’s already weak production may be aggravated by the onset of El Nino. We fear that this upcoming El Nino could be a severe one given that the last region-wide El Nino occurred from 1997 to 1998. We are upgrading KL Kepong, Astra Agro Lestari and Glenealy to Buys, and upgrade IOI Corp from Sell to Neutral. We now have Buy calls across the board, with the exception of IOI Corp. Our fair values are mainly pegged to a 16x CY13 PE. There is room for further an upward revision as the sector re-rates, bearing in mind that the sector used to trade in excess of 20x PE.
Biggest bang for the buck. While we have broad Buy calls, the stocks which could give investors the biggest bang for the buck are the companies which have plenty of young trees and are trading at inexpensive valuations such as SOP, Kencana Agri and BW Plantations. We also like Kulim, which is trading at less than 10x CY13 earnings after stripping out the 93 sen special dividend. We suggest having exposure to both Malaysian and Indonesian plantation stocks as we do not know at this point in time which country will be the worse-off from the impending drought.
If El Nino does not occur. We have been recommending the accumulation of high-quality growth stocks for some time and believe one should be positioned for the eventual slowdown or plateauing of Indonesia’s production. Hence, if the El Nino does not take place or turns out to be a weak one, we still think this is still an opportune time to buy plantation stocks.
Raising average palm oil price to RM3,500 for CY13. We are raising our average palm oil price assumption for CY13 to RM3,500 per tonne, representing a 12.9% increase from our earlier assumption of RM3,100. Compared with the CY12 average of RM3,215 YTD, RM3,500 represents an 8.9% increase, which is consistent with what happened in 2006. However, unlike both the previous episodes, we believe the impact of El Nino will be immediate in the current scenario given that the trees in Malaysia are already experiencing stress due to dry weather in the past 2 to 3 months. This is evident from the recent emergence of two or three unopened “spears” on oil palm trees.
Source: OSK
No comments:
Post a Comment