Plantation - Short term pain, long term gain

Following the recent change in the country’s CPO export tax structure to 4.5%-8.5% with the tax free quota being scrapped, we have now assumed an average discount of 2.0% for the CPO Average Selling Price (ASP) of  all the planters under our coverage for CY13 and CY14. Our applied discount is at the lower end of the theoretical range of 0.0%-4.5% due to the higher need for refineries to compete for CPO production here in Malaysia as compared to Indonesia. In the longer run, we think the discount will shrink when more downstream capacity gets completed in Indonesia, possibly causing an overcapacity of downstream operations there. We expect the big cap integrated players’ (SIME, IOI, KLK) earnings to be little impacted (slight FY13/14 earnings forecast increases of 0.1%-0.6%). However, the pure upstream players’ (GENP, IJMP, TAANN, TSH and UMCCA) FY13/14 earnings forecast are expected to decline in the range of 3.0%-5.5%. Our average CPO price estimate for CY12-CY13 remain unchanged at RM2,975-RM3,000. Integrated planters TP are little changed. Maintain MARKET PERFORM calls on SIME (Unchanged TP of RM9.80), IOICORP (New TP: RM5.20, Old TP: RM5.15) and KLK (Unchanged TP of RM22.30). Pure planters TP are reduced slightly. Maintain MARKET PERFORM on GENP (New TP: RM9.00, Old TP: RM9.25) and IJMP (New TP: RM3.35, Old TP: RM3.38); OUTPERFORM on TSH (New TP: RM2.70, Old TP: RM2.80)  and UMCCA (New TP: RM7.65, Old TP: RM7.70); and UNDERPERFORM on TAANN (New TP: RM3.40, Old TP: RM3.60). Overall, we maintain our NEUTRAL call on the plantation sector. Despite the short term pain for upstream players, we reckon the change is positive for the long run as it should result in better CPO prices after the high inventory is reduced.

Expecting an average discount of 2% to Malaysia’s CPO ASP for CY13 and CY14. This is in line with the recent change in Malaysia’s CPO export tax structure to 4.5%-8.5% with the tax free quota being scrapped, which was announced on 12 Oct. When the new CPO export tax kicks off in 2013, we believe that Malaysia’s palm oil industry will start to mimic the situation in Indonesia where local CPO prices are traded at a discount to international CPO prices. We have chosen 2% discount which is the lower end of theoretical discount range of 0.0%-4.5% based on the current CPO price of RM2300/mt. Compared to Indonesia, we think the magnitude of the discount would be lower in Malaysia as the ratio of refineries capacity to CPO production here is higher at 1.27x against Indonesia’s 1.08x. This suggests a higher competition for CPO as feedstock among refineries in Malaysia as compared to Indonesia, and hence leading to a lower discount in Malaysia. (See details in Page 2). 

But the discount should get lower gradually when more downstream capacity is set up in Indonesia.  At the beginning of 2013, we think that the discount will  be closer to the higher theoretical discount rate of 4.5% but this should gradually be reduced over time. We have assumed an average discount of 2% for the CPO ASPs for CY13 and CY14 but it is possible that the discount may turn out to be even lower than expected due to the risk of an overcapacity in Indonesia. According to media reports, Indonesia’s  downstream refinery is expanding aggressively to 42.9m mt, or c.70% jump vs. Jul 12’s capacity of 25.4m mt.

Slightly positive earnings impact to integrated planters but short term pains for pure upstream planters. Among the big cap integrated planters, we expect slight FY13/14E earnings increases in the range of 0.1%-0.6%. We reckon the net impact to the integrated players to be slightly positive as their downstream capacities are generally bigger than their CPO productions from their own FFBs. Hence, the better margin enjoyed in the downstream division should exceed the losses in the upstream division. As for pure upstream players, we expect their FY13/14E earnings to decline in the range of 3.0%-5.5%.

Long term gain to plantation industry as CPO prices should recover after the high inventory issue is addressed.  We expect Malaysia’s refinery utilisation rate to increase in 2013 from its historical low level of 54.3% in Aug 12 after the implementation of the new CPO export tax structure in Malaysia. This will allow Malaysian downstream players to compete better against Indonesian downstream players. In the longer run, Malaysia’s inventory level should decline (hence better CPO prices) after its downstream players process more local CPOs into processed palm oils (PPO) and eventually export them.

Calculation details. We gather from MPOB that Malaysia’s refineries capacity was at 24.0m mt (as of Sep 12) with a CPO production of 18.9m mt in 2011. For Indonesia, media sources stated that its refineries capacity was at 25.4m as of Jul 12. Lastly, Indonesia’s CPO production in 2011 was 23.5m mt according to the Indonesia Palm Oil Producers Association (GAPKI).  From these data, we arrive at Malaysia’s ratio of refineries capacity to CPO production of 1.27x (24.0/18.9) against Indonesia’s 1.08x (25.4/23.5).

Other possible factors affecting the discount are seasonality, local demand and supply and CPO quality. Although the theoretical discount rate should range from 0.0% to 4.5% (assuming a CPO price of RM2300/mt), we believe that the discount will adjust dynamically to three forces in the market. Firstly, the discount will be higher during a high FFB production season due to the more ample supply of CPOs. Secondly, the number of local refineries around the location of the palm oil estates will also affect the discount rate. Fewer refineries in the same location will result in a higher discount. Lastly, the quality of CPO produced will also affect the discount rate (CPO with better quality deserves better prices, hence lower discount).  

Source: Kenanga