Plantation sector lacks catalysts but hidden gems remain, say analysts

This article first appeared in Capital, The Edge Malaysia Weekly on July 8, 2024 - July 14, 2024

THE first half of this year saw the benchmark FBM KLCI advance 9.3%, with 12 out of 13 sectors contributing to the rally. The plantation sector didn’t join this party. It was the worst-performing sector in 1H2024. It was the only sector in negative territory, declining by 0.4%.

Will the sector reverse course in 2H2024? Don’t bet on it, say analysts. They see a lack of fresh positive catalysts that may drive plantation share prices higher and are expecting crude palm oil (CPO) prices to remain the same in the remainder of the year.

After a roller-coaster ride in 1H2024, with CPO prices trading in the range of RM3,600 to RM4,600 per tonne, analysts are expecting prices to remain volatile given the market and weather uncertainties that could have an impact on crop production and prices.

Analysts including PublicInvest Research plantation analyst Chong Hoe Leong are maintaining their “neutral” call on the plantation sector, given that Malaysia’s CPO production is poised to see stronger growth in the second half of the year as oil palm trees enter a high production cycle, thanks to favourable weather.

Chong says the lack of catalysts to boost investor sentiment contributed to the decline in Bursa Malaysia’s Plantation Index in 1H2024.

“Plantation counters are highly connected with CPO price movements. When there is an uptick or sharp upward movement in CPO prices, plantation counters will also trade at a higher price. If there are no catalysts to drive the price of CPO higher, then we don’t expect an uptick in the price of plantation counters despite [growers making] better earnings in the coming months,” he tells The Edge.

Analysts expect palm oil production to pick up in the coming months, which will increase inventories, potentially exerting downward pressure on CPO prices. In the first five months of this year, CPO production grew 9.4% year on year (y-o-y) to 7.26 million tonnes.

Though La Niña, a weather phenomenon that will bring more rain than usual, may materialise in late 2024, it sets favourable conditions for oil palm trees to produce more fresh fruit bunches (FFB) compared with El Niño, which brings heat and drought, Chong explains.

In fact, the weather may lead to a bumper crop next year.

Chong estimates average production growth of 20% in 2H2024 compared with 1H2024.

He also points to the ample supply of soybean oil — CPO’s closest substitute for food and fuel — from North America entering the global market this year. It is worth noting that CPO prices are closely linked to soybean and crude oil prices.

“A bumper global soybean harvest is expected this year. Overall, 2024/25 global soybeans are projected to hit a record high of 422.2 million tonnes, up 6.6% y-o-y, which could potentially weigh on palm oil prices,” he explains.

TA Securities concurs. “With soybean supply expected to rise, we believe it would be tough to paint a bullish price outlook for CPO due to the substitution effect.”

Amid higher production in 2H2024, Chong expects CPO prices to remain in the range of RM3,800 to RM4,000 per tonne on the back of tight supplies in Indonesia and low palm oil inventory in India and China.

Chong says demand for palm oil is likely to remain steady in 2H2024, unless it is disrupted by unfavourable government policies like the European Union Deforestation Regulation (EUDR), which comes into effect on Dec 30 this year.

He says the new regulation will require companies importing products made from wood, cattle, cocoa, coffee, palm oil and soy to obtain a “due diligence” statement that confirms the goods were not derived from deforested land or links to forest degradation.

“Local refiners who want to export to the EU will only source for Roundtable on Sustainable Palm Oil (RSPO)-certified CPO.

“Currently, 25% of the world’s palm oil production is RSPO-certified. In Malaysia, only big growers produce RSPO-certified palm oil. That’s because, due to the hefty processing costs involved, the adoption of RSPO certification in Malaysia is still low. This could have a severe impact on the local plantation players as they might need to compete for refiners who have accessibility to other markets,” adds Chong.

When announcing its first-quarter 2024 financial results on July 2, Johor Plantations Group Bhd (JPG) — en route to list on the Main Market of Bursa Malaysia on July 9 — said short-term demand for CPO may be influenced by geopolitical events such as the Russia-Ukraine war, conflicts in the Middle East, and the uncertainty in the US Federal Reserve’s interest rate policy.

According to MIDF Research, in 2023, palm oil remained the world’s largest produced vegetable oil at 32% share, followed by soybean oil (23%), rapeseed (12%) and sunflower (9%). The key producers of palm oil remained Indonesia with a share of 59% and Malaysia, 23%.

Exports-wise, palm oil constituted more than half of the vegetable oil market with a 53% share, it said in a Jan 15 report.

Weak downstream profits to persist

Affin Hwang Investment Bank (Affin Hwang IB) is forecasting plantation companies’ earnings to increase by 14.5% in 2024, mainly due to better margins given higher palm product prices and lower fertiliser costs y-o-y.

Key catalysts for the plantation sector are improving market sentiment and a sharp increase in CPO prices due to impact from severe climate change.

“The transition from El Niño–Southern Oscillation-neutral [conditions] to La Niña could potentially happen in 2H2024, with a 65% chance of it developing in July-September and a 85% chance for it to persist into the Northern Hemisphere winter 2024/25 (during November-January). The wet weather conditions during La Niña could result in above-normal rainfall in Malaysia,” Affin Hwang IB said in a July 1 sector outlook report.

However, it believes that price volatility will continue to persist in 2H2024 given the many uncertainties surrounding the agriculture industry as well as the global economy.

It is maintaining a CPO average selling price assumption of RM3,900 to RM4,100 per tonne for this year.

However, analysts expect prospects for the downstream segment to be subdued in the near term.

“Given stiffer competition from Indonesian counterparts due to Indonesia’s policy restricting CPO exports, coupled with weak demand from the oleochemical and biodiesel industries, the business environment for the downstream segment continues to be challenging. Some Malaysian refiners are currently running at losses or at low single-digit margins,” says PublicInvest Research’s Chong.

This is reflected in the results shortfall of integrated players Kuala Lumpur Kepong Bhd (KL:KLK) and IOI Corp Bhd (KL:IOICORP). KLK posted a 46% y-o-y drop in net profit to RM344.01 million in the first half of its financial year ended March 31, 2024, on the back of lower profit contributions from the oleochemical division, refineries and kernel crushing operations. Likewise, lower margins from the oleochemical and refining sub-segments had put a drag on IOI Corp’s net profit, which fell 29% y-o-y to RM762.5 million for the nine months ended March 31, 2024.

Affin Hwang IB concurs that the prospects of the downstream manufacturing businesses are expected to remain challenging given the slow recovery in the global economy and stiff competition, especially from Indonesian refineries.

“As of now, I prefer upstream players. However, [the earnings of] upstream players are highly sensitive to fluctuations in CPO prices and cost of production, which is mainly driven by fertiliser costs. Currently, fertiliser costs are still cheaper than last year’s,” says Chong.

“If you look at the Malaysian Palm Oil Board (MPOB) statistics or any forecast coming from plantation companies, most of them have guided for higher palm oil production for this year because of favourable weather conditions. When you have favourable weather and the fertiliser cost is cheaper compared with last year, production cost will be lower as well. So, even if CPO prices were to remain flat y-o-y, you would still see better results from [upstream] plantation companies like JPG and Kim Loong Resources Bhd (KL:KMLOONG),” he says.

Still, even if earnings from plantation companies are expected to be better in the coming quarters, they are unlikely to drive share prices upwards as plantation counters are driven mostly by CPO price movements.

However, plantation shares can be appealing to investors who are looking for companies with a consistent history of dividend payments. Bloomberg data shows that 14 companies have dividend yields of 2% and above (see Table 1).

Chong likes upstream player Ta Ann Holdings Bhd (KL:TAANN) for the young age profile of its oil palm trees and efficient cost management. He believes the valuation of the stock is attractive, trading below a price-earnings ratio (PER) of 12 times FY2024 estimates. According to Bloomberg, it is trading at 8.82 times 12-month forward earnings.

Similarly, Kenanga Research stated in a June 28 report that it expects better upstream profits on firm CPO prices and easier cost but weak downstream profits to persist on competition arising from excess refining capacity in the region and subdued demand for oleochemicals on a soft global economy.

“Upstream operations are generally very cash generative. Gearing is manageable with many operating out of valuable land bank. The sector’s valuations are not excessive at 1.1 times price to book value (PBV) and 16 times PER.

“The sector is also shariah-compliant, but CPO prices are likely to stay flat, hence there is no compelling upside catalyst for the next quarter or two,” it said.

Kenanga Research prefers growth over yields and upstream-centric players facing easing margin pressures. Hence, it picked PPB Group Bhd (KL:PPB) (target price: RM17.50) for the earnings recovery over its FY2024-FY2025 forecast and exposure to the China, India and Southeast Asia consumer essential food sector.

It also likes TSH Resources Bhd (KL:TSH) (TP: RM1.30), which is busy preparing to expand new planting by 25% to 30% over the coming two to three years, and United Malacca Bhd (KL:UMCCA) (TP: RM6) for its maturing Indonesian estates.

The research firm is forecasting CPO prices to stay firm, averaging at RM3,800 per tonne this year as supply increment trails demand growth.

Rakuten Trade head of research Kenny Yee Shen Pin says with CPO price improving to around RM4,000 per tonne, it may induce some interest in plantation stocks.

He likes pure plantation players such as KLK, Jaya Tiasa Holdings Bhd (KL:JTIASA), Genting Plantations Bhd (KL:GENP) and Hap Seng Plantations Holdings Bhd (KL:HSPLANT), as well as Ta Ann for its dividend yield. Bloomberg data shows analysts are expecting Ta Ann to declare a dividend per share payout of 24.9 sen and 23.1 sen for FY2024 and FY2025, translating into a dividend yield of 6.52% and 6.05% respectively.

In a July 1 market strategy report for 2H2024, Apex Securities stated that it foresees CPO price trending downwards towards RM3,800 per tonne in the second half as palm oil inventory is expected to further expand when the peak season starts.

“We reckon the plantation sector may continue to face headwinds due to higher palm oil production as it enters peak season and further narrowing of the premium between soybean oil and palm oil, stemming from increased planted area and average yield. Hence, we maintain our ‘neutral’ stance on the plantation sector,” the local research firm said.

It added that the plantation sector is trading at a forward PER of 17.2 times and 16.4 times for 2024 and 2025 respectively, and is currently above its historical three-year average of 13.7 times, implying that the sector’s valuation is overstretched at the moment.

Risks to watch out for in 2H2024

For the second half of the year, Affin Hwang IB believes that weather development, global crop production, consumption and movement in stock levels of vegetable oils are factors that could have an impact on CPO prices.

Other key focus points include biodiesel mandates worldwide and changes in government policies and taxes.

“We expect Malaysia’s 2024 CPO production to grow y-o-y by a single-digit percentage as we believe the productivity of workers at the estates has improved as the labour shortage constraints have eased in Malaysia.

“On the cost side, the drop in fertiliser prices has helped to reduce production costs pressure where fertiliser typically accounts for about 10% to 20% of production costs,” it says.

“Overall, we expect CPO prices to remain volatile given the market and weather uncertainties that could have an impact on crop production and prices. Nevertheless, we believe there will be trading opportunities as we expect plantation companies to post better results in 2Q and 3Q of the year,” Affin Hwang IB says, recommending two stocks to buy — Jaya Tiasa and KLK — as it thinks their valuation looks attractive vis-à-vis their peers’.

TA Securities also expects palm oil production to pick up in 2H2024, which “may bring some downside to CPO prices”.

Additionally, the ease in labour shortages is anticipated to further boost CPO production.

“Year to date, the FFB yield increased by 11.1% month on month to 6.2 tonnes per hectare. Production improvements can be expected in 2H2024 due to the easing of foreign labour shortages and favourable weather patterns.

“All in, the CPO production for 2024 is projected to reach 20.2 million tonnes, marking an 8.7% increase compared to the previous year. Meanwhile, Indonesia’s 2024 production is forecast to increase slightly to 54.4 million tonnes from 53.2 million tonnes, as reported by the Indonesian Palm Oil Association (Gapki),” TA Securities said in a July 2 strategy report for 2H2024.

“Indonesia’s reduced palm oil export tariff may pose a threat to Malaysian palm oil exports, which are losing export competitiveness. However, the price spreads between palm oil and soybean oil are becoming more normalised and palm oil remains relatively appealing as an alternative, to some degree,” the local research firm added. TA Securities is projecting CPO prices to average at RM4,000 per tonne in 2024 and RM3,800 per tonne in 2025.

For TA Securities, IOI Corp (TP: RM4.17) and Kim Loong Resources (TP: RM2.50) remained its preferred picks in the sector.

“We are bullish on IOI Corp due to its improving palm oil profile and [the expansion of] its downstream business segment to enhance its future earnings and cushion the impact of lower CPO prices on the plantation segment. We valued the stock based on 2025 PER of 19 times.”

Meanwhile, Kim Loong Resources remains its preferred pick in the upstream segment. TA Securities favours the company for its robust balance sheet with a net cash position of RM379.76 million, supporting a stable dividend yield of 5% to 6% annually. Its valuation of the stock is based on a 2025 PER of 16 times.

Kim Loong Resources’ short-term funds and cash balance stood at RM428.72 million, while borrowings totalled RM48.96 million as at end-April.

Excitement on the horizon for the sector

PublicInvest Research’s Chong sees the possibility of the privatisation of Chin Teck Plantations Bhd (KL:CHINTEK) in the future given the steep discount to its underlying value, noting that the fair value of the group could be worth more than RM900 million, or RM9.84 per share.

Chin Teck executive chairman Goh Wei Lei and his family owned a 37.24% stake in the company through private vehicle Tiong Thye Company Sdn Bhd as at Nov 30, 2023. At its current share price of RM7.33, Chong estimates, the Goh family would have to fork out RM150 million to RM200 million to privatise the group, which has a huge cash pile of RM409 million.

“With a war chest of more than RM400 million, the group can look for merger and acquisition (M&A) opportunities to expand its land bank size in the existing plantation area. We do not rule out the possibility of a privatisation given the current steep discount to its underlying value, which is trading at an unappreciated PER valuation of only two times, after stripping out the cash level of RM409 million and investment securities of RM140 million,” he wrote in a June 28 report.

Chong expects Chin Teck to achieve commendable results for the financial year ending Aug 31 (FY2024), in view of the stronger-than-expected FFB growth for the first nine months amid steady CPO prices. For the first nine months of 2024, FFB production rose 19.9% y-o-y to 177,967 tonnes.

“In view of the improved FFB production and CPO prices, we expect to see better earnings for 3QFY2024, which is expected to be released by the final week of July,” says Chong. Chin Teck’s net profit grew 49% y-o-y to RM42.13 million in 1HFY2024 on higher sales volume of FFB, CPO and palm kernel (PK).

All eyes will also be on upstream player JPG’s listing on July 9, which is expected to raise RM735 million in an initial public offering (IPO). It is set to be the country’s largest listing since Farm Fresh Bhd’s (KL:FFB) RM1 billion offering on March 22, 2022. The dairy producer made a strong debut on the Main Market, rising as much as 38% to its intraday high of RM1.86 compared to its IPO price of RM1.35.

JPG — a wholly-owned subsidiary of Kulim (Malaysia) Bhd, which in turn is a wholly-owned subsidiary of Johor Corp — will be Johor Corp’s second unit to be publicly listed after healthcare unit KPJ Healthcare Bhd (KL:KPJ), which is valued at RM8.8 billion. The proposed IPO involves a public issue of 464 million new shares and an offer for sale of 411 million existing shares at 84 sen apiece. Its expected market capitalisation upon listing is RM2.1 billion.

JPG’s net profit for the first quarter ended March 31 more than doubled to RM49.97 million from RM23.4 million a year earlier, as revenue for the quarter rose to RM294.91 million versus RM251.98 million previously, owing to higher CPO and PK sales and lower operating costs.

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