Remain with well diversified plantation stocks — Analysts

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DOWN CYCLE: Photo shows workers gathering oil palm fruit bunches at a factory in Sepang. Santoso and Quah recommend planters with diversified business portfolios and growth stocks to weather the down cycle next year. — AFP photo

KUCHING: Investors in the oil palm plantation sector have been advised to stick to well diversified plantation players as they would be relatively buffered

from downtrends in crude palm oil (CPO) price fluctuations caused by down cycle production runs and other influential factors faced by the industry.

HwangDBS Vickers Research Sdn Bhd (HwangDBS Research) analysts Benedictus Santoso and Quah He Wei stated, “We expect plantation stock multiples to maintain their downtrend until the middle of calendar year 2012 (CY12) for the two reasons.

“First, our base case calls for a slowdown in gross domestic product growth of Indonesia, Malaysia and Thailand over the next two quarters which requires higher equity risk premiums.

“The second reason is the lower CPO price expectations in the second half of 2012. We expect the peak harvest in the third quarter (3Q) of 2012 to register a healthy supply increase, primarily

from hectarage planted in 2006 and 2007.

“Until then, we recommend planters with diversified business

portfolios such as Sime Darby Plantation Sdn Bhd (Sime Darby) and growth stocks such as First Resources Ltd (First Resources) to weather the down cycle next year,” they underlined.

First Resources still offered attractive total return, mostly coming from its own fresh fruit bunch volume growth. The group also benefitted from the new Indonesian CPO export tax structure, which favoured downstream products.

 

 

With the implementation of the new export tax structure on September 15, 2011, Indonesian palm oil refining margins should improve – provided that refined products’ average selling price was above average cost of CPO inventory.

The main beneficiary of this change would be refineries based in Indonesia, leaving Malaysian refiners having to compete with cheaper Indonesian refined products for the time being.

“Well-run planters can offer an inflation hedge as they represent the high-margin upstream segment of an otherwise resilient staple food industry. Given increasingly well-to-do and populous emerging markets, we also believe the balance of supply and demand will continue to move tighter.

“While our view still calls for bottoming in the short term, we believe plantation stocks should remain attractive over the long term.”

The analysts also noted two trends in the industry to watch for in 2012 as they believed larger plantation groups were expected to continue to expand their businesses through globalisation and integration/diversification.

With dwindling supplies of suitable land, the oil palm business was no longer confined to Indonesia, Malaysia and Thailand, but was expanding into West Africa, led by the sector’s larger players.

According to the Food and Agriculture Organisation (FAO), in 2009 oil palm plantation in Africa covered an area totalling 4.49 million hectares, expected to increase significantly over the next few years.

Led by the biggest players, plantation groups were also diversifying/moving downstream to capture additional margins throughout the palm oil value chain.

These included expansion into oleochemicals, in which palm oil was gradually taking market share over traditional feed stocks such as tallow and coconut oil (due to its relatively cheaper cost).

The oleochemicals industry also had relative advantage by producing high-margin products as an alternative to rising cost of petrochemicals.

Planters had mostly reported higher inventories at the end of September, citing carry over from August holidays and delay in deliveries of presold stock to customers.

However, build up of inventory had consequences: should demand weaken more than expected, further inventory build-up and lower CPO prices would cause planters to face mark-to-market loss on its inventory.

On the other hand, should 4Q11 palm oil output seasonally drop more than expected due to extreme weather conditions, then planters should benefit from higher prices and restocking demand.

From the analysts’ stand point, they did not expect palm oil prices to jump significantly over the next six months because Malaysian stock to usage ratios were flattish while Indonesian stock/usage ratios probably went up.