First Resources - Our Favoured Pick

Reiterate BUY on FR for its good track record of delivering good productivity, it being a beneficiary of the new policies in Indonesia and high leverage on CPO price movements. Based on our re-rated valuation, FR offers 59% upside from its current share price level if a strong El Nino occurs. Its FFB production growth is on track to meet our expectation of 9-11% for 2015. Going forward FR will slow down in new planting activities and focus on sustainability. Target price: S$2.40.

WHAT’S NEW
First Resources’ (FR) share price delivers the best performance among the Singapore listed plantation companies, as crude palm oil (CPO) and soybean oil prices recover post biodiesel-friendly announcements by Indonesia, Malaysia and the US. Based on our recent marketing trips, FR remains as investors’ favourite pick given its good track record to deliver better-than-peers’ performance and good stock liquidity that fit the requirements of larger foreign funds. Its ability to leverage on Indonesia’s policies that encourage value added downstream operations and good production growth will continue to drive its performance.

Beneficiary of new policies in Indonesia. FR’s downstream operations would likely benefit from the implementation of export levy starting on 1 Jul 15. The tax difference between CPO and refined products of US$20/tonne will give refiners a margin buffer. Besides that, the biodiesel subsidy which will be supported by the Crude Palm Oil Supporting Fund’s (CPO Fund) collection of export levy, and the increase in biodiesel mandate would help support FR’s biodiesel production in Indonesia. FR is among the top 5 biodiesel producers in terms of installed capacity in Indonesia.

High leverage on CPO prices. FR stands to benefit from the rising CPO price trends as it is sensitive to CPO price movements due to its good production growth. CPO prices tend to react positively to the El Nino phenomenon. If El Nino turns out to be a strong event, CPO prices are likely to rally. For every RM100/tonne increase in CPO prices, FR’s EPS would increase by 10.5% from our forecasted 2016 EPS. Besides that, the sector will be rerated to 1 SD above its valuation during a strong El Nino event. Based on the rerated target price of S$3.19, there will be 59% potential upside to FR’s share price.

Focus on sustainability. Going forward, FR will be focusing more on sustainability. It is conducting the high carbon stock study for its landbanks to comply with the stringent sustainability requirements. Thus, it has slowed down its new planting activities. FR targets to plant about 5,000-10,000ha of new area in 2015, much lower than 24,000ha planted in 2014. So far, it has planted about 1,984ha in 1Q15 (1Q14: 7,622ha).

STOCK IMPACT
Young age profile to support marginal growth even if El Nino hit. During the previous El Nino in 2009/2010, FR still delivered positive FFB production growth of 2.6% yoy although it was much lower than previous year of 10% yoy. Given its still young age profile with an average of 9 years, in the event that El Nino happens in late-15 to early-16, FR is expected to deliver low-single-digit FFB production growth vs norm of 10-12%.

FFB on track to meet expectations. Its fresh fruit bunch (FFB) production growth of 18% yoy in 4M15 is on track to meet our expectation. For the full year of 2015, we are expecting FFB production growth of 9-11% mainly coming from yield recovery and an increase in new mature area (about 10% of total mature area). Going into 2H15, we expect production to continue to pick up but production trends are likely to be distorted by less harvesting rounds during the fasting month starting mid-Jun 15 and the Ramadan holidays in Jul 15 before picking up again in Aug 15.

Better refining margin from the export levy. FR’s processing plant has a total combined capacity of about 850,000 tonnes p.a., which is larger than that of its upstream operation. The new export tax levy to be implemented on 1 Jul 15 will help boost its downstream margin as there will be about a US$20/tonne spread arising from the difference in export levy between CPO (US$50/tonne) and processed oil (US$30/tonne). On the other hand, we expect increased processing activities in 2Q15 as compared with 1Q15 due to the rising demand during the festive season in Jul 15. The refining business had suffered significantly in 1Q15 due to an unfavourable margin.

Expect better biodiesel demand. With the setting up of the CPO Fund management committee and collection of export levy effective 1 Jul 15, the disbursement of funds to support biodiesel subsidies should be implemented soon. This will lead to higher domestic biodiesel demand as Pertamina is now required to buy and mix diesel to meet the 15% biodiesel (B15) mandate. We believe that the first biodiesel tender/demand from Pertamina for 2015 blending will be announced soon. This is good news for FR as it has a biodiesel plant with a capacity of 250,000 tonnes. So far, FR is focusing on its refining operation as demand for biodiesel is subdued.

Potential inventory drawdown in 2Q15. FR has built up inventory of 20,000 tonnes in 1Q15 which is likely to have been drawn down in 2Q15. This would have boosted sales volume during the quarter. Besides that, although we have seen an increase in palm oil exports in Indonesia in the past few months since the announcement of implementation of export levy, companies might take this last opportunity to export more before the start of the export levy in Jul 15.

EARNINGS REVISION/RISK
No change to our earnings forecasts.


Technical Analysis
Daily Chart
VALUATION/RECOMMENDATION
Maintain BUY and target price of S$2.40, based on 15x 2016F PE. We like FR as it is a beneficiary of Indonesia’s new export levy and biodiesel policies. It also has a good track record of delivering better-than-industry FFB yield and oil extraction rate (OER). 

In the event of El Nino, sector valuation would usually expand closer to 1SD above its mean valuation. Based on a re-rated valuation, the implied target price is S$3.19, and there will be 59% of potential upside to FR’s share price.

SHARE PRICE CATALYST
• Rally in CPO prices.

• Value enhancing acquisitions to expand planted areas given that new planting is getting tougher given the more stringent requirements to comply with sustainability standards.

• Sustainability of better-than-peers’ downstream margin. (Read Report)

Source : UOB KayHian Research

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