Plantation Sector (OVERWEIGHT) Sooner-than-expected recovery? - Danareksa Sekuritas

The CPO price is down 6.0% ytd at US$1,205/ton (10% off this year’s high), largely because of concerns over improving South America soybean production and expected recovery of palm oil production in major exporting countries. Yet we believe these concerns are overdone. This is because: 1) it will be some time before the expected weakening of the “La Nina” weather phenomenon gives way to favorable weather, 2) robust demand for soybeans may continue to support prices, and 3) progressive increases of Indonesian export taxes might limit exports (the January 2011 data shows a monthly decline of 15%). Hence, CPO prices should stay firm until at least 2Q. Beyond this, prices are likely to weaken as demand rationing and an upturn in the yield-cycle might kick in by then. In the sector, we continue to favor BWPT (BW Plantation) given it is a low-cost producer and because of its higher-than-average FFB yield. BUY maintained with a TP of Rp1,350, implying P/E11F of 15.5x.

Is “La Nina” over?
According to the Australian Government Bureau of Meteorology, “La Nina” is expected to weaken during 2Q11. However, a recovery in production remains difficult to predict. This is because the production recovery depends on how quickly the fading “La Nina” gives way to more favorable weather conditions. Note that in the first month of 2011, Malaysia’s total production reached 1.1mn tons, or down 14% mom and 20% yoy. Ending inventory, therefore, hovered at 1.4mn tons as of January 11, a much lower figure than last year (-29% yoy and -12% mom). A substantial improvement in production is only expected to take place in 2H11, with production in a 43% (1H11) to 57% (2H11) ratio, according to the MPOB (Malaysian Palm Oil Board). This suggests that prices – in the short term at least - should hold up.

Soy-oil prices likely to remain high
Despite the better outlook for South American soybean production, we believe that robust demand should continue to support prices. According to USDA, 5mn tons have already been sold through late January, of which 80% are to China. Historically, such high sales have typically not been seen until around March or April. Other key drivers for soy-oil prices include: 1) the US’s bio-diesel mandate, and 2) the March 31 “Prospective Plantings” report which will provide an indication of how US farmers’ acreage is used among key crops. Currently, discount to soy-oil has normalized to US$30/ton vs US$40-50/ton premium at the beginning of this year – lending further support to CPO prices, we believe.

Price sensitivity vs. production sensitivity
Plantations companies are more sensitive toward selling price increases than production growth. Our sensitivity analysis suggests that for every 5% increase in CPO prices, the company’s EPS would be boosted by about 12%. By comparison, every 5% increase in CPO production would boost EPS by less than 10%. This largely explains why plantations stocks have such a strong positive correlation with CPO price movements. In the sector, Astra Agro (AALI) and BW Plantation (BWPT) stand to benefit the most during times of rising CPO prices since they are pure palm plays. However, when CPO prices downturn, the low-cost producers and plantations firms with a relatively higher proportion of plasma plantations would enjoy greater margins sustainability.