PLANTATION - Bracing for all-time high inventory in 4Q1

We expect the general news flows for the Plantation sector in 4Q12 to be likely unexciting with the latest Sep-12 inventory level expected to surge 15% MoM to a record high of 2.43m mt. Note that MPOB is expected to announce this on 10 Oct. Generally, high inventories should keep the upside  for CPO prices limited. The upcoming 3QCY12 earnings results also seem unexciting as earnings should still decline YoY although some QoQ improvements are expected. Lastly, the El Nino threat is also now seen as less severe as the SOI reading has recovered positive 2.4 (as of 23 Sep). With the YTD spot CPO price of RM3095/mt still close to our CY12 estimate of RM3150/mt, we are maintaining our  CPO price forecasts and earnings for planters under our coverage at the current juncture. We maintain a NEUTRAL rating on the plantation sector. Our top picks are TSH (OP; TP: RM2.95) and UMCCA (OP; TP: RM8.05) for their double-digit FFB growth prospects. We are maintaining MARKET PERFORM calls on SIME (TP: RM10.30), IOICORP (TP: RM5.25), KLK (TP: RM24.86), GENP (TP: RM9.70) and IJMP (TP: RM3.65) and an UNDERPERFORM call on TAANN (TP: RM3.75) due to its timber division weakness.

Expect Sep-12 inventory level to reach an all-time high of 2.43m mt. We believe Sep-12 CPO inventory could increase 15% MoM to 2.43m mt as we expect the CPO production of 1.83m mt to continue exceeding exports volume of 1.46m mt. Recall that in Aug-12, stocks were reported at 2.12m mt or at the higher end of the consensus’ estimate of 2.09m-2.14m mt. The strong CPO production of 1.66m mt outpaced the export volume of 1.43m mt, causing inventories to inch 0.12m mt higher to 2.12m mt. We expect this trend (production outpacing export) to continue through 4QCY12, keeping inventory levels above 2.0m mt, a psychological range seen as denoting an ample supply of CPO in the market. Hence, the CPO price upside should be limited.

3QCY12 earnings should improve QoQ  driven by the expected significant jump in CPO production (+26% QoQ to 5.21m mt), which should be more than enough to offset the lower CPO prices (-10% to ~RM2900/mt). A better production level in 3QCY12 is expected due to the recovery from the tree stress effect as well as the seasonal trend factor (3Q production up by 5-14% in the past 3 years). CPO prices have weakened in 3QCY12 as a result of the surge in inventories above 2.0m mt as export growth QoQ failed to catch up with the significantly better production level.

However, 3QCY12 earnings should still decline YoY due to the high base effect of CPO prices and productions last year. The average spot  CPO price should decline ~6% to ~RM2900/mt in 3QCY12 (from RM3092/mt in 3QCY11) in line with the lower soybean oil prices YoY, which has enjoyed high prices last year due to a severe shortage in mid-2011. CPO production should also decline by ~2% YoY due to a  tree stress effect after a strong production year as well as lag effect from El Nino, which occurred 2 years ago. Overall, the expected absence of earnings growth YoY should keep plantation stocks prices upside limited.

We are less concerned on El Nino threat now because the Southern Oscillation Index (SOI) is currently at neutral levels. The latest SOI reading of positive 2.4 (as of 23 Sep) is still at the neutral level. Recall that SOI readings ranging from negative 8 to +8 indicates neutral ENSO levels (no El Nino or La Nina). According to the Australian Bureau Of Meteorology, some of its indicators such as trade winds and tropical  cloud patterns have yet to show typical El Niño signs. Hence, we think that even though there  is a possibility for El Nino to return, it is likely to be a weak one causing little excitement to CPO prices.

Prefer young planters, top picks are TSH and UMCCA. We are maintaining our NEUTRAL rating on the plantation sector but prefer young planters such as TSH (OP; TP: RM2.95) and UMCCA (OP; TP: RM8.05). The average age profile for TSH and UMCCA are at 6.2 and 7.6 years old respectively (youngest among pure planters under our coverage). Due to their high percentage of plantation lands coming into maturity, we expect double-digit FFB growth rates for TSH and UMCCA in the next 2 years.

Source: Kenanga