Macquarie Regional plantations

Not as rosy as it seems

Our strategy for the sector
CPO fundamentals to deteriorate from May: In the near term (read 2009), we believe CPO fundamentals are likely to deteriorate from May. We expect the excitement over low inventories in Malaysia to wane with a pick-up in production from May onwards and export demand to slow down compared to 1Q09, due to inventory build-up in consuming countries such as India.

More positive on the 2010 outlook: For 2010, we turn more positive on CPO but a lot will depend on actual soybean plantings in the US for the current season. We think it is likely that actual soybean acreage in the US will be higher than what is stated in the recent USDA planting intentions report. However, with low soybean stocks in the US, soybean reserve-building in China and poor bean production in South America this year, this means the weather will be a critical factor in determining the supply of oilseeds next year.
Hence, we believe the risk to prices will be on the upside.

A defined trading strategy: We outline potential events that we believe will define a clear trading strategy for CPO stocks over the next 18 months.

Raising our CPO price forecast
Our new CPO price assumptions are US$520/t for 2009, US$625/t for 2010, US$725/t for 2011 and US$690/t for the long term.
Although we have turned positive on CPO prices for 2010 and 2011, we believe the demand-supply fundamentals of edible oils remain fairly balanced and do not foresee a situation that could result in a huge spike in CPO prices to US$800–1,000 levels.

Stock recommendations
Low visibility to the supply situation of oilseeds next year, coupled with expensive valuations for some of the plantation stocks, prevents us from recommending an all-out Overweight for the sector.
Most Malaysian plantation companies trade at 15–17x FY10E on our revised earnings estimates, which are still above their historical trading averages of 13–15x. We believe the market is building a CPO price of US$750–800/t into the valuations of most of these companies. As a result, we maintain our Underperform recommendations on IOI Corp, Sime Darby and Asiatic. On a relative basis, we prefer Kuala Lumpur Kepong (which we upgrade to Neutral) due to higher production growth and better quality earnings.

Among the Indonesian plantation companies, we rate Singapore-listed Indofood Agri Resources as Outperform since, based on at 6.5x 1-year forward earnings, it is the cheapest plantation stock in our coverage universe. We maintain Underperform on Astra Agro Lestari, which trades at 12x 1-year forward PER, slightly above its average of 11x.