• Upgrade to BUY from Neutral, new Target Price of SGD1.90 from SGD1.45, 19% upside. This is on our sector upgrade to OVERWEIGHT, as we expect CPO prices to rerate upwards in 4Q19 and continue increasing in 1H20.
• We believe plantation stocks would also likely rerate on the back of this price movement, as CPO prices are the leading indicator for plantation companies’ P/Es.

When CPO Prices Start Moving, Plantation Companies’ P/Es Will Expand First

• When CPO prices start moving, plantation companies’ P/Es will expand first, before earnings catch up and valuations return to normal. As such, we lift our target P/Es for the plantation stocks under our coverage by 3-5x to trade at 1SD above their historical averages. This is because we expect plantation stocks to trade at more inflated valuations in the short term, before earnings start improving.
• We leave our CPO price assumptions unchanged at MYR2,200/tonne for 2019 and MYR2,400/tonne for 2020.
• The main premises for our upgrade are:
  1. Trade war is still on, with import duties being levied on US soybeans;
  2. A CPO production slowdown is imminent in 2020, while inventories should normalise by 1Q20;
  3. Demand should remain strong from China, due to the continuing African swine flu epidemic in the country;
  4. The B30 biodiesel mandate in Indonesia will mop up any excess supply from the market in 2020;
  5. Crude oil prices will remain at relatively high levels, resulting in a positive CPO-gasoil price gap;
  6. Weather conditions remain normal.

Trade War Continues to Have Far-reaching Effects

• The trade war continues to have far-reaching effects on the sector, not only on soybean demand and supply dynamics, but also on crude oil prices and FX volatilities. This, combined with the improving supply-demand dynamics of the CPO and eight vegetable oil complex, should lead to improved CPO prices in 2020.

Positioned for CPO Price Recovery

• We opine investors should position for the run-up in CPO prices that we expect to see within the next few months, as share prices should also react positively in tandem. In addition, we believe the market would need to look for stock ideas with positive earnings growth momentum during this period of uncertain global economic conditions.

Our Target Price Rises to SGD1.90

• Our Target Price rises to SGD1.90 from SGD1.45, on higher 18x P/E (from 15x), 1SD above FIRST RESOURCES (SGX:EB5)’s historical average. This implies an EV/ha of USD13,000, in line with the peers’ USD10,000-15,000 range.
• Its mostly upstream operations will stand it in good stead in a CPO price upcycle, while it will also benefit from higher biodiesel profits as Indonesia implements its B30 mandate in 2020.
• Upgrade to BUY.

Source: RHB Invest Research - 30 Sep 2019