Plantations Sector Update - Unsustainable - Bahana

Decoupling between robust 4Q10 results and price performance
Recent 4Q10 results from plantation companies under our coverage showed robust growth on higher sales volumes and average selling prices (ASP), which brought industry’s gross margin to around 47.4% from 46.8% in 3Q10. BWPT experienced the biggest y-y increases in sales, operating and net profit due to strong growth in production (exhibit 21). SGRO reported better than expected recovery in its productivity and efficiencies with higher yield and higher gross profit. Apart from UNSP, which reported one-off restructuring gains, other companies mostly experienced positive surprises (exhibit 22). Nevertheless, exhibit 3 shows that the sector has continued to underperform the market by 10% ytd. This decoupling suggests that investors share our concerns on declining performance in 2H11 and beyond on higher CPO supplies.

CPO price outlook: Weighed down by higher supplies
Two CPO supply indicators we follow (exhibit 6 & 7) show supply recoveries are in the making starting February 2011, and likely to persist into 2Q11. As the stock-to-demand ratio moves closer to the historical average of 0.10, we expect CPO price to fall further from current levels. Exhibit 6 shows 8% drop in price since our February sector rating cut, and we expect worse CPO price performance to come. The risk to our call would be slower soyoil planting resulting in higher soyoil prices ahead (exhibit 32). Nevertheless, CPO historical discount to soyoil has varied based on supply disruptions in each of these edible oils (exhibit 31); thus, we do not see CPO price to be much affected by soyoil price hikes, although we do expect the discount to expand from its average of 12%.

1Q11 results: Short-term positive to use as an exit mechanism
In 1Q11, we expect high volumes and high ASP to persist, causing robust results for the industry given that average 1Q11 CPO CIF price reached USD1,237/tons, reflecting IDR7.8m/tons in industry’s net ASP (53.8% y-y). At the same time, we expect production volumes to be lower than 4Q10 level, but still translating to positive growth over 1Q10 (exhibit 6). This is likely to result in improved market underperformance for the Indonesian CPO counters in the short term (3 months). However, this should be used as an exit mechanism as we expect worse performance over the next six to 12 months (exhibit 3).

Prefer smaller cap stocks with BWPT & GZCO as top picks
At this stage of the cycle, we prefer smaller cap BWPT and GZCO as our top picks on much more sustainable growth rates than their peers as reflected in their strong PEG (exhibit 1 & 2). The risk to our Neutral call on the Indonesian plantation sector would be if oil price were to hit highs seen back in 2008, which would in turn push CPO prices to the highs (i.e. close to USD1,400/ ton) experienced in 2008 levels as well.