Rising inventory levels, potential demand shift to soybean during winter, and ESG concerns are near-term headwinds. Narrowing SBO-CPO premium is unlikely to provide price support for CPO. Additionally, the risk of higher taxation cannot be discounted. Our base case assumes no changes to the windfall tax structure and threshold. However, FGV, HSPLANT, TAANN, and UMCCA would be the most impacted by every 1% increase in windfall tax (refer to Exhibit 6). From an earnings front, planters should enjoy sequential earnings improvement in 3QCY21 on CPO price recovery (+6% QoQ) and seasonal production uptick (+7% QoQ). Meanwhile, there is little excitement in terms of biodiesel policies. Indonesia’s B40 plans are expected to be delayed beyond end-2022, but a speedier roll-out will be a positive for the sector. Stay NEUTRAL on the plantation sector with CY21 CPO price forecast of RM3,700/MT. Our integrated pick with defensive overall margin against the CPO price variability is KLK (OP; RM23.60). We also like SIMEPLT (OP; RM4.60) which earnings are relatively shielded by forward sales in a volatile CPO price environment. Additional share price catalyst which will have a spillover effect on the sector is the potential resolution of the WRO by U.S. CBP.

CPO and KLPLN Index review. From a peak in May, crude palm oil (CPO) prices declined (-28%) in June 2021 to a low of ~RM3,500/MT. Since then, prices have staged a recovery (+34%) and is now trading at c.RM4,600/MT. However, during the same period the KLPLN index fell (-5%) and the correlation between CPO price-KLPLN was merely 12%, which we attribute to lingering ESG and production concerns.

Inventory on an upward trajectory. As of August 2021, inventory levels have climbed to c.1.87m MT (+25% MoM) with stock-to-usage (STU) ratio rising to 11% (Exhibit 3). With production remaining relatively strong for peak production months (Sep-Oct), we think inventory levels could climb higher to c.2.0m MT and exert pressure on CPO prices. Drawing hints from the CPO forward curve (Exhibit 2) in backwardation, the direction continues to head south with projected 1HCY22 price of c.RM3,700/MT.

Winter is coming. During the winter months (around Dec to Feb), we could potentially see demand switching from palm oil to soybean oil (SBO) due to soybean oil’s lower solidification temperature. A narrowing SBO-CPO premium (Exhibit 4) of c.USD160/MT (vs. USD400- 500/MT in June-July 2021) could encourage the switch as well. We think SBO price is unlikely to provide price support for CPO price given headwinds like the potential Biden administration’s biofuel cut and good harvesting prospects. The U.S. could be in for a bumper harvest as farmers are more incentivized to increase soybean planting area due to better prices, and as the weather improves.

Biodiesel takes a back seat. With elevated CPO prices, we believe both Indonesia and Malaysia are placing biodiesel mandates on the back burner. According to GAPKI, Indonesia’s B40 plans could be delayed beyond end-2022, while Malaysia’s B20 plans in Sabah and Peninsular Malaysia have been delayed indefinitely. Indonesia’s current biodiesel levy and tax structure (Exhibit 5) are unable to support a sustainable shift to B40, while Malaysia does not have a levy structure to support its biodiesel mandates. Any revision (higher) to biodiesel mandates will be bullish for CPO prices, while benefiting pure Malaysian upsteam planters.

Risk of higher taxation. During our meeting with MPOA, they were somewhat hopeful for the government to address the current tax structure, with potentially higher threshold for windfall tax (from current RM2,500/MT in Peninsular; RM3,000/MT in East Malaysia). However, given the government’s clear intentions to increase tax revenue, we think there could be risks of higher windfall taxes instead. Our base case assumes no changes to the windfall tax structure and threshold. In our scenario analysis, we outlined the estimated impact to planters under our coverage for every 1% increase in windfall tax (refer to Exhibit 6) @ CY21-22E CPO price of RM3,700-3,200/MT, with FGV, HSPLANT, TAANN, and UMCCA the most impacted due to their higher production concentration in Malaysia (refer to Exhibit 7).

Double barrelled boost for 3QCY21 earnings. Driven by CPO price recovery, QTD-3Q average is at c.RM4,400/MT (+6% QoQ). Alongside seasonally higher production in 3Q (we estimate +7% QoQ), we think planters could be in for a sequential earnings improvement. Pure upstream planters like HSPLANT (OP; TP: RM2.30) that have done minimal forward selling would be the clear winners.

Stay NEUTRAL on the plantation sector. While headwinds like: (i) lower CPO price, and (ii) ESG concerns continue to weigh on the sector, we think valuations of planters under our coverage and KLPLN index (-1.0SD to -1.75SD from mean) seem to have priced in the negatives, making an UNDERWEIGHT sector call unfitting, in our opinion. Our CY21 CPO price forecast remains at RM3,700/MT. Our integrated pick with defensive overall margin against the CPO price variability is KLK (OP; RM23.60). We also like SIMEPLT (OP; RM4.60) as its earnings are relatively shielded by forward sales. Additional share price catalyst is the potential resolution of the WRO by U.S. CBP. For smaller cap planters, we think HSPLANT (OP; TP: RM2.30) with minimal forward selling will shine in the 3QCY21 reporting season.

Source: Kenanga Research - 4 Oct 2021