This article first appeared in The Edge Malaysia Weekly on April 24, 2017 - April 30, 2017

DESPITE continued downward pressure on crude palm oil price — now down 17.15% year to date at RM2,666 per tonne — tracking competing edible oils, plantation stocks have been relatively resilient. Not only is the KL Plantation Index trading sideways, it is also showing signs of an upward bias.

A closer look, however, shows that the index has largely been driven by the 31.61% YTD uptick in Felda Global Ventures Holdings Bhd’s (FGV) share price that has made it the top performing plantation stock.

In fact, FGV’s share price rally has helped lift the KL Plantation Index by 43.7% this year.

That said, the index’s price-earnings ratio (PER) of 24.3 times is still below its historical average. The index’s three and five-year  historical PERs are 26.7 times and 25.6 times respectively.

In fact, many of the large-cap plantation stocks are trading at a discount to their historical PERs. Sarawak Oil Palms Bhd (SOP), one of the worst performing plantation stocks this year, is also one of the cheapest in terms of PER. At RM3.44 a share, SOP is valued at only 13.6 times forward earnings.

The average PER of the 15 largest plantation stocks is 20.4 times, excluding outliers like FGV and Kretam Holdings Bhd.

However, some analysts are still bearish on the sector due to external headwinds. It does not help that Malaysian planters are trading at substantially higher valuations compared with their Indonesian counterparts. Take, for example, Singapore-listed First Resources Ltd and Golden Agri Resources Ltd, which are boasting relatively cheap valuations of 15.44 times and 10.27 times respectively.

A major headwind for the industry going forward will be the higher soybean crop plantings this year. Earlier this month, the US Department of Agriculture (USDA) released its “Prospective Plantings Report”, which anticipates a record 89.5 million acres of soybean, up 7.3% year on year, will be planted this year.

“The ample supply of soybean in the market is negative news for palm oil prices. Both soybean and CPO prices have already corrected significantly after the USDA’s reports,” writes TA Securities, which is underweight on the sector, in a report.

Couple that with improving palm oil production and rising inventories and it sets a relatively bearish stage for CPO prices.

This year, CPO production is expected to pick up as the effects of last year’s drought ease. This year, Malaysia’s CPO production is expected to increase to 20 million tonnes from 17.3 million tonnes last year. Similarly, global production is expected to rise 11% to 65 million tonnes.

Last month, Malaysia’s CPO production recovered sharply to 1.5 million tonnes (up 20.9% y-o-y) with strong fresh fruit bunch (FFB) yield of 1.33 tonnes per hectare. This marks the fourth consecutive month of production growth, after over a year of contraction.

While strong production may lift earnings, it will also put downward pressure on CPO prices, especially if soybean production is strong this year as well.

As it stands, palm oil inventories also rose last month, up 6.5% month on month to 1.55 million tonnes. However, stockpiles were 17.6% lower from a year ago, which should provide more breathing room for CPO prices.

Against this backdrop, investors should consider if CPO prices are low enough for a potential rebound. Recall that CPO prices hit a near five-year high of RM3,278 per tonne late last year. Today, prices have eased 18.7% from that peak.

“Assuming exports largely track production movements, we expect a broad but relatively high price range of between RM2,700 and RM3,200 per tonne, based on our stock-to-price studies,” notes Kenanga Research in a report.

However, it also cautions that “in the event of flagging exports, the price outlook is likely to be weak, with a consistent price downward trend to a possible low of RM1,800 per tonne by year end”.

In this regard, it may be more interesting to pay attention to plantation stocks that have more closely tracked the CPO prices. In other words, those that have not seen their share price increase despite the falling CPO prices.

SOP, down 6.5% this year, is one example. Sarawak Plantation Bhd and IJM Plantations Bhd have fallen 10.27% and 9.41% respectively, making them attractive to consider.

Closing at RM3.08 last Friday, IJM Plantations is one of the popular picks in the sector. The company is being valued at a forward 20.95 times earnings, but this is well below the high valuations the stock used to command.

Kenanga Research has a target price of RM3.92 per share on IJM Plantations while TA Securities has a target price of RM3.88, based on a PER target of 23 times.

From a PER valuation perspective, planters like Hap Seng Plantations Holdings Bhd and Kim Loong Resources Bhd are also attractive — 14.97 times and 11.66 times respectively. Both are trading below their three-year average PER as well.

That said, the key for planters to perform in a high production environment is to have higher production growth rates.

In this regard, IJM Plantations and Kim Loong were among the top performers.

Kim Loong saw its FFB production surge 79.5% y-o-y to 32,270 tonnes in March, up from a low base last year. CPO production rose 35.4% in the same period to 23,549 tonnes.

In comparison, IJM Plantations saw FFB production rise to 91,540 tonnes last month, up 43.4% y-o-y. In turn, CPO production rose 30.4% y-o-y to 16,127 tonnes.

SOP’s FFB production rose 41.4% y-o-y last month to 99,123 tonnes. CPO production, however, lagged at 29,288 tonnes — an increase of 17.4% y-o-y.

Hap Seng Plantations’ lower PER was justified by lower FFB growth. The group saw its FFB production increase only 10.1% in the same period to 46,221 tonnes. CPO production was flat — up 1.6% y-o-y to 10,449 tonnes.

Put it all together and the recent fall in CPO prices should not weigh too heavily on plantation stocks with strong FFB production growth. In fact, it may present a good opportunity for investment in the sector amid the relatively bearish sentiment.

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