Recapping a disappointing quarter. Investors hoping for a turnaround in the fortunes of this sector would have generally been disappointed with the recent set of 2QCY12 results. In our opinion, Noble had the best quarter, with a yoy recurring net profit growth of 5% despite a delayed sugar crop at its Brazilian mills. Olam saw a 11% decline in recurring net profit on the back of weak numbers for industrial raw materials. Wilmar on the other hand, had another shocker of a quarter, with recurring net profit down 55% yoy, justifying our SELL call and our least preference within the sector.

China’s soft landing still appears hard. Similar to last quarter, most of the earnings weakness still appears to be traceable to China, the incremental driver of commodity demand. Even with the government’s stimulus measures, GDP growth decelerated to 7.6% yoy in Q2, while the latest PMI figures showed a first contraction in nine months, which could drag growth into the 3rd quarter at least.

No clear benefit from impending QE. While most agree there is a positive impact, it is more observable for futures price and in more financialised commodities. Underlying demand/supply equation is more dictative for physical deliveries. Fundamentally, these commodity traders are mostly price neutral with the exception of selective upstream exposure. The increase in price volatility however, increases counterparty risk, or if these companies opt for a lower-risk mode, the ability to generate profit will be adversely affected.

QE3 effect on stock prices. Given that these are highly traded beta-names, we also observe the impact of QE on stock prices. While QE1 was a positive catalyst for a rally in these stocks, the impact of QE2 was front-loaded before the announcement. Assuming a QE3 announcement during the next Sep 12-13 FOMC meeting, we think positive share price impact is likely to be even more muted than QE2 and probably already factored in by now.

Our sector preference remains Noble. Given our cautious sector outlook, our top pick remains Noble. We see an earnings recovery story in the current financial year, as well as a more diversified portfolio from energy to agriculture. Balance sheet also looks robust with the receipt of cash from Yancoal-Gloucester deal over the next six months. Maintain BUY on Noble and SELL on Wilmar, upgrade Olam to HOLD.

Source: Maybank Kim Eng Research - 6 Sept 2012