Sarawak Oil Palms (SOP) remains our top Malaysian sector pick, along with Kulim. We are maintaining our BUY call with FV at RM9.37. The company met 17 fund managers in KL recently. Following our upgrade to OVERWEIGHT on the plantation sector on expectations of an El Nino lifting prices in 2013, we raise our FY13 earnings estimates by 6%. As SOP’s production was lacklustre in 1H2012, we cut our FY12 FFB production growth forecast and FY12 earnings estimates by 8%. Y-o-y production growth has narrowed substantially since April, while this year’s tree output may be skewed towards 2H2012. We see FY12 FFB production growth clocking in at 10.3%, followed by a 10.2% increase in 2013.
Less plentiful despite benign weather. SOP’s FFB production struggled in 2Q2012, in line with the Malaysian plantation industry’s weaker output. 2Q production sank 9.8% y-o-y, bringing 1H2012 production to 355,876 tonnes, some 2.5% less than 1H2011’s output. It was weaker despite the near-perfect weather (i.e. abundant sunshine in the day, showers in the evening) since October 2011, as the tail-end of the 1Q2010 drought suppressed crop yield.
Soft 2Q production. April was the month that was hardest hit, as the FFB harvested declined 19.4% y-o-y. Monthly y-o-y production growth had remained in negative territory, but improved substantially to a more manageable -5.3% (see Figure 1). 2Q2012 production, however, did go up by 18.2% q-o-q as palm output entered its seasonal up-cycle. SOP performed comparatively better than its country peers as a whole as Malaysia’s CPO production dropped 9.1% y-o-y in 1H2012, with the 2Q2012 production falling by 17.9% y-o-y but rising by 11.9% q-o-q.
Planted area now totals 62,948 ha. With 68.2% of the company’s 62,948 ha of planted area still below peak production, organic production growth from SOP’s comparatively younger tree age profile aided the company in weathering some of the unfavourable climate effects on output. New planting was, however, slower in 1Q2012, with planted area increasing by just 193 ha during the quarter as the company focused on getting its maiden refinery in Bintulu on-stream. SOP is looking to plant new trees on 2.8k ha by end-2012, which will increase the total planted area to 66,000 ha. This will pretty much exhaust its existing 72,653 ha landbank. The company is still waiting for Sarawak plantation land prices to soften before expanding its landbank and remains cautious about expanding to Indonesia.
Raising tax-free CPO export quota? As reported in the papers, the potential 2m-tonne increase in tax-free CPO export quota, if implemented, is meant to temporarily ease CPO stockpile in the country amid an environment of increasing production and decreasing exports. The move counters most industry players’ expectations of a more downstream-friendly policy. We understand that only 10%-20% of the existing full year quota remains prior to the potential 2m-tonne quota increase. Societe Generale de Surveillance (SGS) estimates that Malaysian July palm oil exports declined by 18.5% m-o-m as purchasers switched to cheaper Indonesian palm oil (SGS estimate: +23% m-o-m).
Pure refiners hit hardest. Independent refiners like Mewah International will be the hardest hit as pure CPO producers get more leeway in deciding whether to export their products or sell locally. Peninsular Malaysia refiners, who have paid higher than the rest of the country’s average prices for CPO due to the region’s excess refining capacity, will likely face further capacity underutilization and thinning refining margins. Meanwhile, Sarawakian refiners are also likely to lose bargaining power but may experience less dire circumstances than their peninsula counterparts in view of the refining capacity shortage in the state. We think integrated players will find the additional quota less of a problem in relation to CPO sourcing if their refineries are self-sustaining. As SOP’s own CPO production accounts for 70% of its refinery’s capacity, this helps to mitigate concerns of under-utilization.
8% FY12 earnings contraction. In view of 1H2012’s weak production, we are toning down our FY12 FFB production growth forecast to 10.3% from 16.1% previously. Nonetheless, this still implies a 20.5% y-o-y growth for 2H2012, in line with our view that production will be skewed towards the 2nd half of the year compared to 2011. Following the production revision, our FY12 earnings expectations are correspondingly cut by 7.7%, implying an 8.4% y-o-y profit contraction.
41% FY13 earnings growth. We recently upgraded SOP’s FY13 estimated earnings to RM314.1m, up 5.7% from RM297.1m previously. The upward revision followed our 2013 average CPO price assumption upgrade to RM3,500 per tonne, which led to positive FY13 earnings adjustments across our plantation universe. The move to OVERWEIGHT the plantation sector on 9 July 2012 stems from our belief that palm prices will enter a three-year upcycle soon, fuelled by the possibility of an El Nino occurring in 4QCY12/1QCY13 and a potential peak in Indonesia’s production in 2015. We also cut our FY13 production forecast to 1.0m tonnes (+10.2% y-o-y) from 1.08m tonnes previously on expectations that an El Nino will curb output growth.
Maintain BUY. Following our sector-wide earnings revision, we value SOP at RM9.37, based on a 13.0x FY13 PER. Despite our forecast changes and a likely challenging 2QFY12 earnings performance, the company is still trading at an attractive 13.4x FY12 PER and 9.5x FY13 PER. SOP continues to be a BUY and our top Malaysian sector pick for its strong growth prospects and solid management expertise.
Source: OSK
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