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This article first appeared in The Edge Financial Daily on January 26, 2018

Sarawak Oil Palms Bhd
(Jan 25, RM3.79)
Maintain buy with a fair value (FV) of RM4.85:
At a bargain valuation of forward  price-earnings ratio (PER) of 9.4 times on financial year 2018 (FY18) earnings per share (EPS) of 40.2 sen, we believe Sarawak Oil Palms Bhd is undervalued, as the stock is trading below -0.5 standard deviation (SD) of its three-year mean forward PER of 14.6 times. This is unjustified given its positive fresh fruit bunch (FFB) growth and yield outlook, combined with its integrated business model whereby Sarawak Oil Palms operates one of the only five refineries in Sarawak. We estimate Sarawak Oil Palms accounts for 32% of the state’s total refining capacity. As such, in our view the stock has ample room to be rerated higher considering that the valuations of its integrated peers such as IOI Corp, Kuala Lumpur Kepong Bhd (KLK) and Genting Plantations Bhd (GENP) are presently trading at 22 times to 26.2 times forward PER — though we would only expect parity if Sarawak Oil Palms further develops its downstream capabilities and expands upstream to reach a scale closer to the larger players.

We forecast FY17 to FY18 FFB output to grow by 36% to 37% to 1.37 billion tonnes to 1.47 billion tonnes lifted by higher FFB yields as highlighted above. Our FY17 estimated output growth is supported by industry-wide production recovery, favourable weather and additional contribution from Shin Yang Oil Palm. Meanwhile, the FY18 forecast is premised on rising contribution from maturing hectarage. Overall, we expect to see FY17 to FY18 revenue rising by 2% to 4% to RM4.50 billion to RM4.68 billion. Despite the high quantum of FY17 FFB growth, we note that revenue has not increased as much due to a higher base after its refinery came onstream and boosted FY14 to FY15 revenue by 68% to 28%. Furthermore, the higher internal FFB reduced buying requirements for the refinery, resulting in the lower share of external purchases.

We expect net margins recovery from the FY16 low of 3% to 4.9% for FY17 to FY18, respectively. This is supported by lower production cost due to higher FFB yield leading to cost efficiency. Our model indicates that Sarawak Oil Palms achieved a low all-in cost of production at about RM840 per tonne in 2016, despite its young age profile. We estimate FY17 crude palm oil (CPO) price of RM2,600 per tonne, but a lower assumption of RM2,400 per tonne for FY18 on softer 2018 CPO prices outlook due to oversupply in production, given that most planters in Malaysia and the region could see recovery from the severe drought seen from 2015 to 2016.

Trading “buy” with a FV of RM4.85 based on an applied PER of 12 times on FY18 EPS of 40.2 sen, below its historical three-year mean forward PER of 14.6 times. Our undemanding valuation implies a 50% discount to our plantation universe PER of 23.1 times given Sarawak Oil Palms’ smaller profit base and market capitalisation of RM2.16 billion (versus the sector average of about RM8.19 billion). We believe our discount is fair considering it is below average FY17 to FY18 profit after tax (PAT) margins of 4.9% to 4.9% against downstream players’ average of 7.4%, as well as its smaller planted land bank of 87,700ha against the integrated players’ average planted land bank of 145,900ha. In spite of this, our valuation is still attractive providing a total return of 29.8% (upside: 27.6%, dividend yield 2.1%). — Kenanga Research, Jan 25

 

 

 

 

 

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