Friday 29 Mar 2024
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ALTHOUGH the price of crude palm oil (CPO) has largely stabilised at around RM2,200 per tonne over the past six months, the earnings of plantation companies have continued to weaken, as reflected in the latest results season.

A key concern now is that despite a slew of bullish catalysts on the horizon, such as El Niño and Indonesia’s B15 implementation, major plantation players remain encumbered by lower operating margins as well as high unrealised foreign exchange losses.

Weaker average selling prices and lower fresh fruit bunch (FFB) output in the first quarter of the year resulted in a major earnings decline among the upstream players. Apart from the decline in revenue, the lower FFB output has also dented operating margins, as millers were underutilised following floods in the East Coast states late last year.

Rabobank International director of food and agribusiness research Pawan Kumar says the earnings outlook for plantation firms remains bleak for the rest of the year. “We forecast both production and CPO prices to remain weak in the second quarter. Existing negative fundamentals will hit the pure players the hardest. But the integrated players are better capitalised and can actively pursue income diversification. Those with downstream exposure in Indonesia have an added advantage,” he says.

This will put the spotlight on companies such as Singapore-listed Wilmar International Ltd and Golden Agri-Resources Ltd, which are large integrated players with substantial downstream operations in Indonesia. The Indonesian government has big plans to support domestic palm oil consumption, including its push for the implementation of the B15 biodiesel mandate as well as export levies of US$50 per tonne for CPO and US$30 per tonne for processed palm oil products.

The two initiatives will stoke up domestic demand in Indonesia, which in turn will help the refiners that are currently operating at well below capacity. The proposed levies will go towards subsidising its biodiesel industry, incentivising plantation companies to ramp up production.

“In the near term, we prefer integrated players that are able to enjoy the margin difference on the levy of US$20 per tonne between upstream and downstream products,” says CIMB Research analyst Maureen Natasha in a May research note.

Wilmar (fundamental: 0.80; valuation: 1.00) owns two biodiesel plants in Indonesia with a combined capacity of two million kilolitres per annum. Similarly, Golden Agri-Resources (fundamental: 0.55; valuation: 1.20) has committed up to US$300 million to expand its downstream operations in Indonesia.

Jakarta-listed integrated players such as PT Astra Agro Lestari Tbk and PT Salim Ivomas Pratama Tbk are also expected to benefit, as palm oil exports form only a small proportion of their total sales.

Malaysian integrated players look set to continue to be affected by weaker upstream contributions and lack of government support in the downstream segment. With no direct subsidies, unlike in Indonesia, refiners continue to operate well below capacity and post losses due to negative refining margins.

The reliance on contributions from the upstream segment was reflected in the recent results for the quarter ended March 31, which seemed to have underwhelmed analysts’ consensus expectations. For example, Sime Darby Bhd’s plantations division saw its gross profit decline 7.8% y-o-y to RM99.6 million for the quarter ended March 31, 2015, due to low production and weak selling prices.

Profit at its midstream and downstream operations fell 55.3% to RM30.3 million from RM67.8 million a year ago.

“The lower profit was attributable to lower off-take of biodiesel from petroleum companies due to the drop in crude oil prices and lower sales volume of differentiated products,” Sime Darby (fundamental: 0.80; valuation: 1.40) says in notes to its financial statements.

Major players such as Felda Global Ventures Bhd (FGV) and Genting Plantations Bhd saw double-digit percentage declines in their FFB production on an annual basis, which affected their gross incomes.

For 1QFY2015, FGV (fundamental: 1.55; valuation: 1.40) reported a 38% drop in gross profit to RM363.1 million year-on-year while Genting Plantations (fundamental: 1.20; valuation: 1.10) saw its gross profit fall 25% y-o-y to RM115.1 million.

However, even gross profits are being diluted from the companies’ foreign exchange exposure, as has been the case over the past year. The ringgit and rupiah have plummeted to new multi-year lows.

“It is not just a question of compressed margins anymore. Unrealised forex losses are a long-term burden as we do not see any recovery for Asian currencies against the US dollar. While unseasonable weather can bring down production from record high levels, regional and global demand for palm oil is still the key determinant of prices,” says a plantations analyst at a bank-backed research house.

The forex exposure of some of the integrated players has impacted their net income. For example, IOI Corp Bhd (fundamental: 1.20; valuation: 1.10) reported a net loss of RM188 million on the back of unrealised forex losses of RM333 million. Similarly, IJM Plantations Bhd (fundamental: 1.60; valuation: 0.80) saw its net profit dwindle to RM10 million in its latest quarterly results, largely due to unrealised forex losses of RM51.36 million.

Rabobank’s Kumar says a silver lining for the upstream players would be the growth in India’s demand for palm oil. “Imports should continue to pick up this year mainly because there is not a lot of domestic supply in India. An expected widening of the spread between soy oil and palm oil prices will also be supportive of the latter, as edible oil consumers will become more price sensitive.”

Weak demand for palm oil this year has resulted in a growing stockpile, despite the bump in exports seen recently. According to Malaysian Palm Oil Board data, the closing stock of crude and processed palm oil in Malaysia amounted to 2.19 million tonnes, not far from the all-time high of 2.62 million tonnes recorded in 2013. The government has decided to keep export tax at zero until the end of June in a bid to clear existing stock.

The bullish catalysts, while good for investor sentiment, is unlikely to have an impact on CPO’s fundamentals anytime soon, at least until the current stockpile can be meaningfully reduced. According to Anglo-Eastern Plantations PLC executive director of finance Datuk Lim Ewe Chuan, this is the main factor that influences the industry’s future prospects.

“In the near term, any upside on the CPO price may be limited in view of seasonally higher production and large stockpiles,” he says.

 

This article first appeared in The Edge Malaysia Weekly, on June 1 - 7, 2015.

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