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This article first appeared in The Edge Financial Daily on July 5, 2018

IOI Corp Bhd
(July 4, RM4.46)
Maintain sell with a higher target price (TP) of RM3.70:
Post disposal of Loders Croklaan Group, IOI Corp Bhd’s management is looking for opportunities to acquire new land bank to further expand its upstream and downstream operations, which mainly focus on the palm-based industry. However, there is no attractive deal on hand now. For the first 11 months of financial year 2018 (11MFY18), fresh fruit bunch (FFB) production was 3.3 million tonnes, on track to meet our expectations of 3.5 million tonnes (+12% year-on-year [y-o-y]). Its fourth quarter of the financial year ended June 30, 2018 (4QFY18) results are likely to be weaker quarter-on-quarter (q-o-q) and y-o-y on a softer crude palm oil (CPO) average selling price.

IOI transferred 70% of its equity interest in Loders on March 1, 2018. The sales proceeds will be utilised for repayment of borrowings (50%), working capital (29.75%), dividends (20%) and disposal expenses (0.25%). Management targets to focus on planting 8,000ha of new areas in the next three years post-disposal, bringing its total planted land bank to 29,000ha. Post-disposal of Loders, 50% of the sales proceeds will be utilised for repayment of bank borrowings. Its net gearing ratio improved to 0.32 times from 0.78 times as of June 2017, which has strengthened its balance sheet position and provided IOI room to leverage if there is suitable land bank. However, we understand that the acquisition of new land bank might not be easy due to the strict new planting policy, stringent sustainability regulation and high land prices.

The Sustainable Palm Oil Policy is the main guiding document for IOI’s sustainability practices, which was first launched in March 14 and revised in Aug 16. A few measures have been taken by IOI to ensure the sustainability of palm oil production and sourcing. IOI is committed to apply the newly revised High Carbon Stock Approach methodology. Moreover, another key area that IOI is enhancing its effort is human rights and the workplace, which includes no recruitment fees charged on workers, payment of the monthly minimum wage in accordance with the current labour regulations, and access of trade unions to workers.

We expect June FFB production to come in weaker month-on-month on lesser harvesting days due to the Hari Raya holidays in the middle of the month. Every 1% increase in FFB production growth would increase our FY18 net profit forecast by 1.4%.

As such, 4QFY18 FFB production is likely to be weaker q-o-q, but could be flat or marginally higher y-o-y (3QFY18: 866,790 tonnes; 4QFY17: 799,779 tonnes).

The weakening of CPO prices could be due to concerns over palm oil supply outweighing demand and leading to an increase in palm oil inventory.

The performance of IOI’s downstream operation has stabilised over the past three quarters with the disposal of its stake in Loders to Bunge. Meanwhile, the group’s oleochemical segment is expected to improve as global and regional economies continue to grow steadily.

Following the completion of the disposal, IOI holds a 30% associate stake in Loders. The disposal exercise could improve Loders’ market presence by tapping Bunge’s geographical presence in regions that IOI currently does not have access to. This will help to increase sales of Loders in the long term. Moreover, partnering with Bunge will give IOI better access to other soft-oil markets. Thus, Loders’ contribution could double from the current contribution in five years’ time.

We maintain our FY18 to FY20 earnings estimates. We forecast earnings per share of 16.8 sen, 20.1 sen and 21.1 sen for FY18 to FY20 respectively.

We maintain our “sell” rating, with a higher sum-of-parts TP of RM3.70 (from RM3.60) as we include the contribution from its 30% stake in Loders. Our TP implies 18 times FY19 forecast (F) price-earnings ratio (PER), or -1 standard deviation (SD) of its five-year mean PER, in line with sector peers’ valuations (ascribed PER of -1SD of the five-year mean) due to the weak CPO price outlook for 2018.

Its share price has fallen 7.4% from a high of RM4.86 on May 14, 2018, reflecting its weak quarterly earnings. Despite the recent decline, the stock is still trading at a rich 27 times FY18F PER, which is +0.5SD of the five-year mean. — UOB Kay Hian, July 4

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