LOOKING at the results of some of the bigger listed plantation players, especially those with downstream exposure, the sector’s latest reporting season is likely to disappoint. While this is largely anticipated, the outlook for the sector is looking dim as well.

In their financials for the quarter ended Dec 31, 2014, plantation giants IOI Corp Bhd and Kuala Lumpur Kepong Bhd showed margin compression due mainly to lower average selling prices.

Crude palm oil (CPO) prices lost as much as 33% last year to close at RM1,929 per tonne at the end of August from RM2,885 in March, bringing the average price for 2014 to about RM2,400 per tonne. Early this month, however, the commodity recovered some 9% to RM2,300 per tonne.

Prices never quite got the much-needed boost last year from a potential El Niño, which would have curtailed production.

In its second quarter ended Dec 31, 2014, IOI Corp (fundamental: 1.7; valuation: 2.1) saw net profit tumble 96% to RM19.6 million from a year ago on the back of a slight decrease in revenue to RM2.88 billion from RM2.94 billion previously.

KLK’s (fundamental: 1.3; valuation: 0.7) net profit for the quarter dipped as well — to RM214.2 million from RM292.68 million the year before — although revenue rose to RM3.1 billion from RM2.49 billion in 2013.

“Plantation [pre-tax] profit dropped 5.7% [year on year] to RM242.1 million due mainly to the weaker selling prices of CPO and rubber, reduced crop production of both fresh fruit bunches (FFB) and rubber, and higher production cost of CPO,” KLK says in a filing with Bursa Malaysia.

Its average selling price for CPO fell 6.8% year on year to RM2,138 per tonne while that of IOI Corp contracted 9.7% to RM2,187.

IOI Corp said its plantation profit decreased 4% y-o-y to RM297.3 million during the quarter, due mainly to lower CPO and palm kernel oil prices. Its downstream segment was also hit hard, declining 19% y-o-y to RM215 million on lower margins from the oleochemical subsector.

The company also saw huge foreign exchange translation losses of RM274 million mainly from US dollar denominated debt.

“This pattern will follow across the board this reporting season for all plantation counters exposed to downstream operations and US dollar denominated debt because of the way the ringgit has depreciated against the US dollar,” says an analyst with an international banking institution.

Note that unrealised forex translation losses are not actual cash transactions but are reflected in the profit and loss account as a result of fluctuating currencies, like in IOI Corp’s case.

“The downstream players will be worst hit because their inventories must be marked-to-market and this will reflect lower CPO prices,” says the analyst. But this is not to say the upstream players are insulated. They too suffer a direct impact from CPO price changes.

Maybank Investment Bank Research points out in a Feb 13 report that while zero CPO export duty has benefited the upstream players (with no export taxes), it has been a bane for refiners in the region that are suffering from overcapacity.

Malaysia has 58 operating refineries worth RM2.9 billion, according to the Palm Oil Refiners Association of Malaysia (PORAM). The biggest refiners include IOI Corp, Felda Global Ventures Holdings Bhd, Mewah International Inc and Wilmar International Ltd.

As it is, many refiners in Malaysia have been in negative margin territory for almost half a year now, says PORAM chief executive Mohammad Jaaffar Ahmad.

This is because the government decided to suspend export duty on CPO in September 2014.

Following the slight recovery in  CPO prices early this month, the market was expecting the tax to resume in March. But the government has since announced that March will remain duty free as the average price has yet to exceed the RM2,250 threshold.

For as long as there is no export tax on CPO, refiners will generally suffer negative margins as the price differential between refined palm oil and CPO is currently insufficient to cover costs.

“As long as the price of CPO is below the threshold price of RM2,250, there should be zero CPO export tax,” Jaaffar tells The Edge.

“Based on the current price trend, futures market, stock levels, market demand and stock levels in importing countries, plus parameters beyond our control, such as the overhanging high production and stock of other vegetable oils and depressed crude oil prices, we see the price of CPO subdued in the first quarter of 2015.”

This will be reflected in the next reporting season, he adds.

Jaafar is not the only one forecasting lacklustre prices. “We forecast CPO prices to average RM2,100 in 2015 after taking into account the weaker ringgit,” says Insider Asia.

“We expect single-digit earnings contraction for the sector as a whole this year with output growth partially offsetting the price decline.”

This seems to be at the lower end of expectations with some analysts keeping CPO price forecasts as high as RM2,650. “I’m waiting for the Indonesian biodiesel mandate to be confirmed and planting intentions of the US at the end of March before adjusting the price forecast. It is still too early to tell,” says an analyst.

The Indonesian government recently raised its subsidy for biodiesel to IDR4,000 per litre from IDR1,500 to support biodiesel usage amidst the decline in crude oil prices. Crude oil prices have more than halved since August 2014, making biodiesel blends less competitive in contrast.

“If the government has strong willpower, then the economics of crude oil to biodiesel blending may not be as important a factor as CPO prices,” CIMB Research analyst Ivy Ng says. But she notes that at the present crude oil prices, subsidies are required to keep biodiesel in demand.

Despite the expectation of slightly lower production in Malaysia on the back of floods in December, palm oil stocks came in at 2.015 million tonnes in 2014 compared with 1.987 million tonnes in 2013.

That said, forecasters are expecting inventory levels to come off this year — conventionally, a boon for prices. But one must take into account the bumper soybean crop in the US, which was estimated at 4 billion bushels last year. “That is forecast to grow 11% this year,” says the analyst with the international bank.

All things considered, it is not easy to see light at the end of the tunnel for the plantation sector.

Note: The Edge Research’s fundamental score reflects a company’s profitability and balance sheet strength, calculated based on historical numbers. The valuation score determines if a stock is attractively valued or not, also based on historical numbers. A score of 3 suggests strong fundamentals and attractive valuations. Visit www.theedgemarkets.com for more details on a company’s financial dashboard.

This article first appeared in The Edge Malaysia Weekly, on February 23 - 29, 2015.

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