ASEAN Plantations - A more compelling narrative for 2016


Event
The narrative for CPO planters will be better in 2016 than it has been in many years as the complex is set to tighten. We see next year’s average CPO prices 18% higher than the 2015 average, and 30% higher than the 4Q15 average. We think the Singapore listed planters are the best plays, despite some ‘sticker shock’ risk around IAS 16 adoption. FR is our top pick.

Impact
CPO complex set to tighten: Supply will stagnate on the back of this year’s El Nino (moisture deficit) and S/E Asian haze (sunlight deficit). Indonesian biodiesel provides an incremental demand boost. These key catalysts have gone from brewing to bubbling. Our 2016E stock-to-usage ratio for CPO of 17.7% would be as tight as it has been since 2010.

Soybean oil (SBO) and crude oil are the risks to watch as both are well supplied. But we’d note that SBO accounts for only 26% of world vegetable oil production and 16% of exports, versus palm oil at 39% and 66%. We accept that low crude oil prices limit the demand for discretionary biodiesel blending. But we think there are enough export CPO tax receipts to sustain the funding of Indonesia’s mandated biodiesel programme (low crude oil prices versus CPO prices increase the cost of subsidizing the programme).

Risk reward on CPO price and planter share prices skewed to upside. While we have only raised our 2016E CPO price by 5% to US$659 per ton from our October update, we are gaining higher incremental confidence in our bull case (US$735) versus our bear case (US$560). For one, 3Q15 company commentary confirmed the supply risk heading into the new year. Secondly, we had positive newsflow on Indonesia’s biodiesel mandate. On that basis, we also see risk reward on share prices as skewed to the upside (Figs 4-5).

We think the market is now largely aware of the IAS 16 ‘sticker shock’ risk in the new year. This accounting change will lower book value and raise depreciation charges for Singapore listed planters from 2016. Whilst there is no cash impact from the changes, PE and P/BV ratios are set to rise, as we first analysed here (figs 6-9 re-summarize the main impacts).

Outlook
We like the plantation sector for 2016 as it has a fundamental tailwind in the form of rising CPO prices. FR is our top pick. While it is less sensitive to CPO prices than most upstream peers, we like the relative predictability of its high production growth and high margin business model.

We also like IFAR, the cheapest upstream name in the group both pre and post IAS 16. GGR is less favoured given its patchy results track record but we raise it to Outperform on valuation. GGR is most correlated to CPO prices too.

Wilmar is less of a CPO price play but we think recent share price weakness has been driven by excessive concerns over its so-called carry trade income stream, which has opened a buying opportunity.

We remain Neutral on Sime Darby, where we see downside earnings risk on its non-plantation operations. Isaac Chow is initiating on KLK today with a Neutral citing the stock’s fair valuation. (Read Report)

Source : Macquarie Equities Research

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