CPO and share prices of producers diverge

This article first appeared in The Edge Malaysia Weekly, on February 22, 2021 - February 28, 2021.
CPO and share prices of producers diverge
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WHY are plantation stocks not on the radar of investors even though crude palm oil (CPO) prices have gained as much as 18% from RM3,070 per tonne on Nov 3 last year to RM3,632 per tonne last Wednesday?

Analysts say there are several factors dampening prices, but warn that environmental, social and governance (ESG) issues that now plague the sector could be the most damaging if not swiftly addressed. This is because international investors are increasingly placing great value on such practices.

As Covid-19 vaccines are now available, investors have shifted their attention from glove makers and manufacturers of personal protective equipment to technology stocks, owing mainly to strong demand for semiconductors. The lack of interest in plantation stocks is palpable as reflected in the Bursa Malaysia plantation index.

The index, which tracks the performance of 43 listed planters on Bursa Malaysia, gained a mere 4% in the period from Nov 3 to last Wednesday. Some of the heavyweights have registered even poorer gains: Sime Darby Plantation Bhd managed just a 2% rise to RM4.90, whereas IOI Corp Bhd declined 3% to RM4.20.

The correlation coefficient between CPO prices and plantation stocks recently narrowed from last year, says Kenanga Research analyst Adrian Kok of the mild increase in the index signals.

“I want to point out that there is still a strong correlation between CPO prices and plantation stocks — in 2020, it was at 0.75 and in 4Q2020 at 0.88. It is only recently [when CPO prices exceeded RM3,500 per tonne], that we see the correlation weakening at 0.22,” he tells The Edge.

Kok attributes the narrowing correlation between CPO prices and plantation stocks to two factors: the sustainability of current CPO prices; and the earnings growth of the companies.

“Generally, I think market participants’ view of the current CPO price is that it is not sustainable beyond RM3,500, per tonne and perhaps that is why the correlation weakened. You would have heard many comments from notable speakers talking about a decline in the second half of this year,” he says.

He points out the current rally in CPO prices is driven by the tight supply of the commodity, which is reflected in the Malaysian Palm Oil Board’s inventory levels.

“This means that while we can generally expect plantation companies’ profits to improve, the impact of higher CPO prices will be partially neutralised by lower production. There is also an unaddressed risk to production with regard to foreign labour shortage, which will become more apparent during the peak production period. That said, our base case is that the labour shortage will be resolved before the peak production period.

“To aid our country’s economic recovery, the government has to address this issue, which is not limited to the plantation sector. The construction and manufacturing sectors, which are vital to the country’s economic recovery, also face similar labour issues,” he says.

ESG issues have also plagued the plantation sector. Last year, the US Customs and Border Protection (CBP) issued a ban on palm oil and products of two Malaysian plantation companies — FGV Holdings Bhd and Sime Darby Plantation.

To an extent, this move has had an impact on the share price of Malaysian planters, owing to the perception of weaker ESG practices.

Chris Eng, chief strategy officer at Etiqa Insurance & Takaful, observes that the negative environmental and social perception associated with some plantation firms “seems to have kept a lid on plantation stock prices, although this is also partly due to expectations of rising production in the second half of 2021”.

“Nonetheless, commodity prices may still provide a bit of a lift in the coming months to plantation stocks, especially if foreign selling abates. For now, it’s a reminder that any Malaysian company that seeks to do business internationally needs to look at all their ESG practices via an international lens,” he cautions.

Pankaj C Kumar, a former head of research and fund manager, says ESG issues are taken seriously by today’s investors.

“The ban put up by US CBP causes investors to shy away from putting monies into these companies, as no matter how attractive the fundamentals are, their mandate will not allow them to invest when a company has a weak ESG score or fails to adhere to ESG standards,” Pankaj says.

To a certain extent, he adds, local palm oil players are faced with a supply squeeze because of a labour shortage as well as low-production months. “The cold snap in the US has also caused soy oil prices to rise, thus CPO prices have appreciated as well.”

Which plantation stocks to invest in?

Generally, local plantation stocks are expensive relative to those in the region, notes TA Investment Management chief investment officer Choo Swee Kee. “We are trading at 30 times price earnings (PE) while regional ones are less than 20 times. Most investors believe the high CPO price is not sustainable, so they don’t want to chase up plantation stocks.”

Choo is positive on pure upstream players such as Sarawak Oil Palms Bhd (SOP), TSH Resources Bhd, Hap Seng Plantations Holdings Bhd and Ta Ann Holdings Bhd.

From Nov 3 to last Wednesday, SOP shares have appreciated 16% to RM4.04; TSH Resources, by 14% to RM1.08; Ta Ann, by 10% to RM2.85; and Hap Seng Plantations, by 8% to RM1.80.

Kenanga’s Kok is overall neutral on the plantation sector, but advocates building positions in integrated players such as Kuala Lumpur Kepong Bhd (KLK) and IOI Corp. Based on its 4QFY2020 performance, he recommends Hap Seng Plantations, which he says is undervalued and boasts decent CPO output and estates that are 100% in Malaysia, thus allowing the group to fully benefit from higher CPO prices.

KLK shares have appreciated 5% since Nov 3 to RM22.76 last Wednesday, and Kenanga has an “outperform” call on the stock, with a target price of RM26.80.

Following the release of its results for the first quarter of its financial year ending Sept 30, 2021 — which RHB Research says has outperformed estimates, as profit is up year-on-year across all segments — the brokerage says it expects KLK’s FY2021 earnings to grow 52% y-o-y, premised on the production recovery of fresh fruit bunches, higher CPO prices and better downstream margins.

RHB has maintained its “buy” call on KLK, with a target price of RM27.80.

Meanwhile, UOB Kay Hian maintained its “market weight” call on the sector, with a CPO price assumption of RM3,000 per tonne for 2021.

“We remain concerned on potential price weakness, owing to the strong production recovery in 2H2021, and demand rationing with high CPO prices.

“We also observe that Malaysian plantation companies’ stocks are trading sideways compared with Singapore and Indonesian plantation companies’ stocks, which have risen 20% to 30% since November 2020. We reckon that this is mainly due to concern over ESG issues affecting Malaysian companies,” the firm says, adding it prefers planters with a higher upstream exposure in Malaysia.

“We prefer pure upstream players with only Malaysia-skewed operations, that is, Hap Seng Plantations, SOP and Kim Loong Resources, as they would benefit more from higher selling prices versus peers with Indonesia exposure. Among the big caps in Malaysia, we have a ‘buy’ call on KLK [with a target price of RM26],” the brokerage says.

 

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