no | date | house | price | target | recommendation
| | 1 | 8Sept08 | am | | | UNDERWEIGHT
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| 1 | Sector update: Impact of weaker Ringgit
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| 2 | 11Sept08 | am | | | UNDERWEIGHT
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| 2 | Sector update 1:Palm oil inventory declines in August
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| 3 | 11Sept08 | am | | | UNDERWEIGHT
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| 3 | Sector update 2: Biodiesel exports set to grow, says NST
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| 4 | 15Sept08 | am | | | UNDERWEIGHT
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| 4 | Sector update : PE compression to continue
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| 5 | 18Sept08 | cimb | | | UNDERWEIGHT, Maintain
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| 5 | Sector update : Crude awakening for CPO price
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| 6 | 11Sept08 | ta | 6.20 | 7.60 | buy ,Upgrade
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| 6 | United Malacca Berhad,Attractive Valuation.
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| 7 | 29Aug08 | osk | 0.38 | 0.36 | NEUTRAL,Maintain
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| 7 | Leweko: 1HFY08 Results Review ,Going gets tougher
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| 8 | 2Sept08 | s&p | 0.38 | 0.49 | hold
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| 8 | Leweko : results review
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| 9 | 15Sept08 | kenanga | 3.02 | 2.7 | hold
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| 9 | Sarawak Plantation : Results Note ,1H08 slightly lower
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| 10 | 17Sept08 | am | 2.56 | 1.9 | SELL
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| 10 | SOP : Enters into JV to develop 14,500 ha of land
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| 11 | 8Sept08 | zj | 2.72 | 3.62 | buy
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| 11 | QL : 1Q RESULTS UDPATE for FYE09 (draft)
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| 12 | 18Sept08 | am | 2.67 | 3.43 | buy, unchange
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| 12 | QL:Company visit,Sets out next chapter of growth
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| 13 | 2Sept08 | osk | 7.6 | 11.8 | TRADING BUY Maintain
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| 13 | Kulim (M) 1HFY08 Results, Seasonally Weaker
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| 14 | 11Sept08 | osk | 2.8 | 3.26 | BUY,Initiate
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| 14 | CCM : Initiating Coverage ,Getting the Chemistry Right
|
skip to end1.Sector update: Impact of weaker Ringgit back to topThe Malaysian Ringgit (RM) has declined from a high of US$1.00:RM3.132 on 23 April this year to US$1.00:RM3.4175 last Friday . A weaker RM relative to the US$ would benefit the plantation companies.
However, there could be higher fertiliser costs as fertiliser are imported in US$. But if crude oil prices were to continue its downward trend, then the negative impact from the weaker exchange rate on fertiliser costs should be cushioned as crude oil derivatives are used to make fertiliser.
Among the plantation companies under our coverage, the impact of a weaker US$/ RM exchange rate is stronger on the purer and smaller plantation companies like TH Plantations and Sarawak Oil Palms (SOP). The impact on the bigger plantation companies is less because of their more diversifed earnings base.
IOI Corporation’s (IOI) FY09F net profit would improve by 4% assuming the RM softens from US$1.00:RM3.30 to US$1.00:RM3.50 with all things being constant (please refer to Table 1). However, this would be partly offset by increased borrowing costs as about 61% of IOI’s borrowings are denominated in US$.
Based on the same assumptions, we estimate Kuala Lumpur Kepong’s (KLK) FY09F net profit would rise by 5% while Sime Darby’s would inch up by 6%. Kulim’s FY09F net earnings would expand by 5%.
Among the smaller plantation companies, SOP would benefit the most from a weaker RM. The group’s FY09F net profit would rise 8% while TH Plantations’ would improve 7%.
We maintain an UNDERWEIGHT on the plantation sector as the supply imbalance and soft crude oil prices will continue to exert downward pressure on CPO prices.
2.Sector update 1:Palm oil inventory declines in August back to topMPOB released the country’s CPO (crude palm oil) statistics for the month of August yesterday afternoon. In summary, the statistics showed declining palm oil inventory on the back of lower output.
Price discount widens: Average CPO price was RM2,674/tonne in August. Yearto- date, CPO price averaged RM3,404/tonne. The discount between soybean and CPO prices widened from 25.3% in July to 33.2% in August. This is near the high of a 39.7% price discount recorded in October 2001. In the past five years, the price discount between the two commodities averaged 19.4%.
CPO output on track: After a bumper harvest in the first half of the year, CPO output finally showed slower growth in August. CPO production inched up only 2.5% MoM and 2.6% YoY to 1.6 million tonnes in August. Year-to-date, CPO output amounted to 11.4 million tonnes, 18.4% higher than the same period last year. It appears that CPO production is on track towards meeting MPOB’s projected output of 17 million tonnes for the full year.
Second monthly decline: Palm oil inventory declined from 1.98 million tonnes in July to 1.85 million tonnes in August. This is the second consecutive monthly decrease since the record level of 2.03 million tonnes in July. We attribute the fall in palm oil inventory level in August to lower output resulting from stress after a good harvest in 1H.
Exports growth softer: CPO exports climbed 4.6% MoM and 17.9% YoY to 1.47 million tonnes in August. It appears that the export growth in August is softening compared to July’s 25.2% MoM and 26.4% YoY increases. We believe that the growth in palm oil demand in August was mainly driven by the Ramadan and Deepavali period in India and Pakistan. On a MoM basis, palm oil exports to China declined 11.7% to 369,019 tonnes in August.
China tops: In the first eight months of this year, CPO exports totalled 9.79 million tonnes, 16.6% YoY higher. From Jan to August this year, China accounted for 26.2% of the country’s palm oil exports. This was followed by Pakistan (8.1%) and Netherlands (7.6%).
Positive but ... : Despite August’s positive set of statistics, we maintain an UNDERWEIGHT on the plantation sector as uncertainties over CPO prices resulting from supply imbalances next year and weak crude oil prices, would put a dampener on share prices.
3.Sector update 2: Biodiesel exports set to grow, says NST back to topMalaysia is on track to ship out 143,000 tonnes of biodiesel this year, 50% more than last year as biodiesel producers reap fatter margins, according to the NST today.
Biodiesel exports in the first eight months of the year amounted to 101,835 tonnes, 7% higher than last year’s 95,013 tonnes, said the Malaysian Palm Oil Board.
Based on a selling price of US$1,000/tonne for biodiesel and other operating costs of US$100/tonne, the breakeven feedstock cost for biodiesel would be about US$900/tonne or RM3,060/tonne. This implies that biodiesel is presently feasible based on current CPO (crude palm oil) prices of RM2,300/tonne to RM2,400/tonne.
However, as the winter season is coming, we expect biodiesel exports to USA and Europe to soften as palm oil-based biodiesel freezes during cold weather. Hence, blenders and consumers prefer to use biodiesel based on other vegetable oils such as rapeseed.
Of concern is also the weakening crude oil prices, which will exert downward pressure on the selling prices of biodiesel. Therefore, although biodiesel margins are expanding now, they could narrow in the future.
Sime Darby used to have 290,000 tonnes of biodiesel capacity annually. However, its two plants in Malaysia have been converted into oleochemical facilities while the one in Rotterdam (200,000 tonnes/year) has not commenced operations yet. Kulim’s biodiesel plant was also converted into an oleochemical facility as previously, biodiesel was not feasible due to high CPO prices.
Among the companies under our coverage, Wilmar International has the largest biodiesel capacity of 1.15 million tonnes annually. Recently, Wilmar indicated that it may ramp up its biodiesel production capacity by another 50%.
We believe that the amount of biodiesel exports is still not significant enough to absorb the country’s high palm oil inventory level of 1.85 million tonnes. Falling crude oil prices and a supply imbalance are also expected to continue to dampen CPO prices. Hence, we maintain an UNDERWEIGHT on the plantation sector.
4.Sector update : PE compression to continue back to top
Investment Highlights
We are retaining our UNDERWEIGHT stance on the plantation sector. Although the share prices of plantation companies appear to have capitulated on heavy selling in recent days, we caution that it is too early to bottom-fish for value. If history is of any guide, we believe that the downside risk potential in this previously over-owned sector is still significant on three counts:-
(1) First, the recent collapse in the CPO pricing cycle was admittedly steeper and swifter than our already bearish expectations, with the decline accentuated by the collapse in crude oil price and an adverse change in bio-diesel policy in EU where lawmakers voted to effectively cut the biofuel target for 2020 from 10% to 6%. The price of CPO (crude palm oil) has already fallen by some 37% off the monthly high of RM3,680/tonne to RM2,300/tonne currently. In the last three downcycles, the peak-to-trough price correction ranged between 35% - 72% (see Table 4).
(a) 4Q08 is expected to be seasonally stronger due to stronger demand from the festive period but any meaningful price recovery may be capped by rising production. We believe that CPO is just at the mid-point of a pricing downcycle. Against this backdrop, we are cutting our average CPO price assumption from RM3,000/tonne to RM2,200/tonne for 2009, and to remain flat at best in 2010.
(2) Second, we believe that the sharp sell-offs have also caught many plantation companies by surprise. Our discussions with a few plantation companies have revealed that they are still selling mostly at spot prices. An added drag on earnings may come from the high cost of fertiliser. Although crude oil prices have weakened, an industry player has indicated that fertiliser costs may only soften in 2H09 due to the lagged effect.
(a) We are cutting our earnings estimates for FY09F by some 7% - 44% across the board to reflect our new CPO price assumption. Tradewinds Plantation will be most affected by the CPO pricing downcycle given its high exposure to the upstream segment, followed by Sarawak Oil Palms and TH Plantations. The earnings impact for Wilmar is more muted, cushioned by its relatively large downstream earnings (67% of group earnings).
(b) Following our earnings revisions, we now expect the earnings of the plantation sector to decline by 11% in 2009F (2008F: +17%). We have also cut our dividend assumptions.
(3) Third, PE de-rating is expected to persist. From a valuation standpoint, we find that the plantations companies are still trading on lofty multiples. During the CPO price downturn in 2001 (see Charts 1 and 2), IOI’s PE valuation dropped to a low of 10x. In comparison, based on the current CPO price assumption of RM2,300/tonne, IOI’s fully diluted FY09F PE would be 16.6x.
In arriving at IOI’s new RNAV-based target price, we have decided to use the mean PE of 13x. This coupled with our CPO price assumption of RM2,200/tonne translates into a target price of RM3.65/share for the group.
For Kuala Lumpur Kepong (KLK), the group’s FY09F PE would be 15.9x based on the current CPO price of RM2,300/tonne. KLK’s PE at its 7-year low was about 11x (see Chart 3). We estimate KLK’s target price at RM8.25/share assuming a 13x PE on FY09F plantation earnings, underpinned by an average CPO price of RM2,200/tonne.
5.Sector update : Crude awakening for CPO price back to topDowngrade of in-house crude oil price assumptions. Our regional oil analyst is scaling back his crude oil price forecasts today. Instead of a strengthening of oil price in 2009, we now expect it to decline by US$10 to US$90/barrel, a US$30 downgrade from our previous forecast. Effectively, we have cut our forecasts by US$10 for 2008, US$30 for 2009 and US$20 for 2010 (see today’s regional oil report). This has implications for our CPO price forecasts as a lower crude oil price reduces the economic viability of biodiesel.
Cutting CPO price forecasts. In view of our lower crude oil price assumptions and rising supply prospects for CPO, we are pruning our CPO price forecasts by 12% to US$920 per tonne (fob) for 2008, 34% to US$680 for 2009 and 30% to US$660 for 2010.
Cutting earnings and target prices. Our new price forecasts translate into downward revisions of up to 55% for our FY08-10 earnings forecasts for all the plantation companies in our universe. This, coupled with the 1-3 multiple pt reduction in our P/E targets, has the effect of slashing our target prices by 19-60%.
Sime Darby downgraded to UNDERPERFORM. Following our earnings forecasts and target price revisions, we relegate Sime Darby from Neutral to UNDERPERFORM in view of its less exciting earnings prospects. There is no change to our rating for the other regional planters.
Switching preference to Singapore-listed planters. Regionally, we are switching our preference to planters listed in Singapore and Indonesia as their share prices have fallen more steeply than their Malaysian peers. Also, political risk is now lower in Indonesia than in Malaysia. Between Singapore and Indonesia-listed planters, we prefer the former as they offer better share liquidity and bigger market caps.
Staying UNDERWEIGHT on sector. The downgrade in our price forecasts reinforces our UNDERWEIGHT stance on the sector. Rising operating costs and the deteriorating outlook for CPO price due to a combination of rising supply prospects and slowing demand growth will crimp earnings in the coming years. Key de-rating catalysts are lower prices for CPO and crude and rising operating costs. The main risks to our forecasts and sector call are a sharp recovery in crude oil price, weaker US$ and lower-than-expected edible oil supplies due to weather disasters.
Outlook
CPO price on a losing streak. International CPO price has come off another 33% since our last report on 8 August 2008. All in, it is down 52% (US$723 per tonne) from the year’s high of US$1,395 per tonne and 11% since the beginning of the year. The halving from the year’s high is the steepest correction for the CPO price since 1990 and took place within the short span of six months. Currently, CPO price is at a 17- month low.
Turning into a bear market? Bearish newsflow continues to hold sway over the CPO market since our last regional plantation report where we highlighted the rising downside risk to CPO price. The adverse newflow which has pushed CPO to a new low for the year includes:
1. Crude oil price has lost a further US$22/barrel or 18% since our last note. This has the effect of lowering the breakeven CPO price for biodiesel conversion. Furthermore, there are reports that the EU is looking to modify its biofuel target by moving away from traditional first-generation feedstock crops to “new alternatives” that do not compete with food production. These two factors have dampened the prospects of CPO being converted for biodiesel usage.
2. US soyabean plantings have so far been spared by frost risks. This raises the expectation of a good harvest for US soyabean crops. Also, rapeseed crops have so far been above expectations in Europe and Ukraine.
3. Palm oil is currently in its peak production season. Malaysia’s high palm oil stock level of 1.8m tonnes and reports of a record stockpile of 2.4m tonnes at Indonesian ports have spooked the market.
4. The volatility and continued downtrend for both CPO and crude oil price have rattled sentiment in the market. Consumers are delaying their purchases or buying on an as-need basis in anticipation of further price declines. As such, palm exports may be slower than earlier expected by the market.
5. Worries of a slowdown of global economies continue to weigh down demand expectations for edible oils.
6. The flow of funds out of commodities adds to the CPO price decline.
7. Prominent oilseeds and edible oils grain analysts have been downgrading their CPO price expectation in recently organised conferences.
Cutting crude oil price forecast
Downgrade of in-house crude oil price assumptions. Our regional oil analyst is scaling back his crude oil price forecasts today. Instead of a strengthening of oil price in 2009, we now expect it to decline by US$30 to US$90/barrel in 2009 and US$20 to US$90/barrel in 2010 (see today’s regional oil report). This works out to 9-25% cuts in our earlier projections.
Crude oil’s influence on palm oil price. Crude oil’s price spiral was one of the major factors that drove up CPO prices in 2007 as it made it the conversion of CPO into biodiesel economically viable. However, the correlation between the two broke down this year as CPO price rocketed past crude oil price on the back of its own fundamentals (refer to Figure 4). The rise in CPO price in the early part of the year was stoked by fears of a potential shortfall in global edible oil supplies due to adverse weather and competition with grain products for acreage. With CPO price at much higher levels, it became unfeasible to use CPO as a feedstock for biodiesel except where the government mandates the usage of biodiesel in 1H08. As a result, producers have scaled back the use of palm oil for energy purposes in the EU and Asia in 2Q08. This has affected the demand for edible oils, partly contributing to the setback in CPO price in 3Q08.
Economically viable to produce biodiesel again… Given the sharper fall in CPO price relative to crude oil price in recent months, we find that conversion of palm oil to biodiesel is again an economically viable proposition, especially with the support of government subsidies. We understand that some biodiesel producers have started to increase production, helping to rekindle the positive correlation between the two commodities.
…. but rising operating challenges as well. Though biodiesel production is now feasible from an economic standpoint, the operating environment has also become more challenging due to the increased volatility of both crude oil and CPO prices. The sharp fall in crude oil price will make it harder for biodiesel producers to hedge the prices of their end-products. Also, palm oil-based biodiesel may face resistance in the EU market due to sustainability issues. Also, due to its properties, palm-based biodiesel is not suitable during the winter season in Europe.
Sensitivity of CPO biodiesel breakeven price to crude oil price changes. The lower crude oil price reduces the economic viability of biodiesel and ethanol and may cut demand for edible oils and grains for energy purposes. It also provides a lower support price for CPO. Our breakeven model suggests that at a crude oil price of US$100 per barrel, it is economical to produce biodiesel when CPO price on a fob basis is no higher than US$673 (RM2,323) per tonne assuming no government subsidies and US$823 (RM2,840) per tonne with government subsidies. This is slightly lower than the current spot CPO price of US$690 (RM2,350) per tonne. Based on our model, the sensitivity of CPO price to every US$10 per barrel change in crude oil price is US$70 (RM238) per tonne, based on the current exchange rate (see Figure 6). In our analysis, we have assumed government subsidies of US$300 per tonne of biodiesel and an equal split of the subsidies between biodiesel producers and distributors. Hence, the subsidies to biodiesel producers amount to exactly US$150 per tonne in our calculation.
Other notable development
EU biofuel targets to be modified? Last Thursday, the European Parliament’s influential industry committee endorsed the general 10% target for biofuels in transport but added a number of modifications aimed at moving away from traditional biofuels made from grains and other crops toward other, renewable energy sources. It called for 5% of transport fuels to come from renewable sources by 2015, with at least a fifth of the amount coming from “new alternatives” that do not compete with food production. The “new alternatives” could include sources like hydrogen or electricity from renewable sources, or biofuels made from water, algae or non-food vegetation.
Although it stuck to the 10% biofuel target for 2020, it said that at least 40% should be made from “second-generation” renewable sources and the target will be reviewed in 2014. This is not final and the Parliament and EU governments must still reach agreement on any targets before they become law. Implementation of the above would lead to slower demand growth for biodiesel made from first-generation food crops. This is because it is a lower target than the EU’s earlier voluntary biodiesel target of 5.75% for 2010. Based on the new plan, it would appear that biofuel from first-generation crops will form only 4% of transport fuel in 2015 as opposed to the earlier plan of 5.75% for 2010. As the EU has already achieved around 3%, future expansion in demand for biofuel is likely to be on a voluntary basis and less dependent on governments’ push/incentives.
CPO price forecast downgrades
Cutting CPO price forecasts. In view of our lower crude oil price assumptions and rising supply prospects for CPO, we are pruning our CPO (fob) price forecasts by 12% to US$920 per tonne (fob) for 2008, 34% to US$680 for 2009 and 30% to US$660 for 2010. We now expect international CPO price to rise by 25%, instead of 42% in 2008 before declining by 26% in 2009 and 3% in 2010. In tandem with our international CPO price downgrade, we have cut our Malaysian CPO price assumptions by RM320 per tonne to RM3,030 (fob) for 2008, RM700 per tonne to RM2,300 per tonne for 2009 and RM550 per tonne to RM2,200 for 2010. Our 2008 price forecast also takes into consideration the RM3,344 CPO price achieved in the first eight months of the year and recent developments.
Basis of our new CPO price forecast. In view of the unwinding of speculative funds out of the commodity market, we have removed the premium that we earlier attached to CPO price for this factor. Secondly, we have taken into consideration the improving supply prospects reported so far and relatively fair weather at key planting areas for the remainder of the year. Thirdly, we have factored in our new crude oil price forecasts. Lastly, we have also accounted for the recent changes in our forex assumptions which call for a weaker ringgit and rupiah. We recently adjusted our RM/US$1 year-end forecasts to RM3.50 for end-2008 (RM2.95 previously), RM3.40 for end-2009 (RM2.80 previously) and RM3.35 (RM2.85) for end-2010. For the rupiah, we are tweaking our year-end forecasts to Rp9,000/US$1 by end-2008 till end-2010 (from Rp8,500 previously for end-08 and 09 and Rp8,800 for end-2010). Our new CPO price forecast for 2009 is close to the average breakeven CPO price for biodiesel conversion, with and without subsidies based on our new crude oil price projections.
Valuation and recommendation
Slashing earnings by up to 55% for FY08-10. We have chopped our FY08-10 earnings forecasts for all the plantation companies under our coverage by up to 55% after incorporating our new CPO price forecasts. Our new earnings numbers also factor in a lower increase in fertiliser cost. We now expect fertiliser prices to be flattish next year in view of the weaker mineral oil prices. In the case of companies with estates in Indonesia, we also take into consideration the lower CPO export tax and the recent cut in corporate tax rate from 30% to 28% for 2009 and 25% for 2010. All in, the earnings adjustment was most significant for purer palm oil plays, in particular pure planters listed in Indonesia and Singapore. In our universe, the stock that is least affected is Wilmar, thanks to its large oilseed crushing and downstream palm processing businesses.
Chopping target prices by 19-60%. Our target prices for all the planters in our universe have been scaled back by 19-60% for our new earnings forecasts as well as cuts in our target P/E ratings. For almost all the planters, we have clipped 1-2 multiple points off their target P/Es following recent downgrades in the target P/E for both the Malaysian and Indonesian markets.
Sime Darby downgraded to UNDERPERFORM. Following our earnings forecasts and target price revisions, we relegate Sime Darby from Neutral to UNDERPERFORM in view of its less exciting earnings prospects. However, we do see some share price support from its dividend yields. There is no change to our ratings for all the other plantation stocks in the region.
Market has not priced in all the bad news. The share prices of all the listed planters have corrected significantly since we downgraded the sector to Underweight on 18 July 2008 (see Figure 11). We believe the steep price decline is justified as the plantation stocks have to adjust not only for the CPO price downswing and rising costs but also the deteriorating equity market conditions. We feel that the market has not priced in all the bad news, specifically the cost increases that planters are likely to report in the upcoming results as rising fertiliser and fuel prices start to kick in. The time is not ripe for investors to venture back into the sector as pessimism on CPO price is not at its height yet and bears continue to prevail in the stock market. This may limit the upside to plantation share prices even if CPO prices start to recover.
Switching preference to Indonesian and Singapore-listed planters. Regionally, we are switching our preference to planters listed in Singapore and Indonesia as their share prices have fallen more steeply than their Malaysian peers. Also, political risk is now lower in Indonesia than in Malaysia. In Malaysia, aside from political risks and CPO price outlook, foreigners own substantial slices of the listed planters’ shares Between Singapore and Indonesia-listed planters, we prefer the former as they offer better share liquidity and bigger market caps.
Maintain UNDERWEIGHT on the sector. The downgrade in our price forecasts reinforces our UNDERWEIGHT stance on the sector. Increasing operating costs and the deteriorating outlook for CPO price due to a combination of rising supply prospects and slowing demand growth will crimp earnings in the coming quarters. There may be downside risk to our CPO price estimates if crude oil price extends its downtrend, palm oil stocks continue to rise and governments make a U-turn in their biofuel policies. The key risks to our forecasts and sector call are a sharp recovery in crude oil price, weaker US$ and lower-than-expected edible oil supplies due to weather disasters.
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QUICK TAKES
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Sime Darby Bhd
CPO price forecast downgrades
Downgrade of in-house crude oil price assumptions. Our regional oil analyst is scaling back his crude oil price forecasts today. Instead of a strengthening of oil price in 2009, we now expect it to decline by US$10 to US$90/barrel, a US$30 downgrade from our previous forecast. Effectively, we have cut our forecasts by US$10 for 2008, US$30 for 2009 and US$20 for 2010 (see today’s regional oil report). This has implications for our CPO price forecasts as a lower crude oil price reduces the economic viability of biodiesel. Essentially, it provides a lower floor price for CPO.
Cutting CPO price forecasts. In view of our lower crude oil price assumptions and rising supply prospects for CPO, we are pruning our CPO (fob) price forecasts by 12% to US$920 per tonne (fob) for 2008, 34% to US$680 for 2009 and 30% to US$660 for 2010. We now expect international CPO price to rise by 25%, instead of 42% in 2008 before declining by 26% in 2009 and 3% in 2010. In tandem with our international CPO price downgrade, we have cut our Malaysian CPO price assumptions by RM320 per tonne to RM3,030 (fob) for 2008, RM700 per tonne to RM2,300 per tonne for 2009 and RM550 per tonne to RM2,200 for 2010. Our 2008 price forecast also takes into consideration the RM3,344 CPO price achieved in the first eight months of the year and recent developments.
Basis of our new CPO price forecast. In view of the unwinding of speculative funds out of the commodity market, we have removed the premium that we earlier attached to CPO price for this factor. Secondly, we have taken into consideration the improving supply prospects reported so far and relatively fair weather at key planting areas for the remainder of the year. Thirdly, we have factored in our new crude oil price forecasts. Lastly, we have also accounted for the recent changes in our forex assumptions which call for a weaker ringgit and rupiah. Our new CPO price forecast for 2009 is close to the average breakeven CPO price for biodiesel conversion, with and without subsidies based on our new crude oil price projections.
Valuation and recommendation
Lowering earnings forecasts and target price. We are cutting our earnings forecasts by 19-24% to account for our new CPO price forecasts. This, coupled with our downgrade of our target P/E for the group’s plantation unit from 12x to 11x in tandem with the recent reduction in our target market P/E, has the effect of lowering our SOP-based target price from RM7.50 to RM6.05. Our new price objective implies a CY09 P/E of 11.3x, which represents a discount to our target market P/E of 12x given its less exciting earnings prospects compared to the market.
Downgrade to UNDERPERFORM due to lower upside. In line with our target price downgrade, we have cut our rating for Sime Darby from Neutral to UNDERPERFORM. The stock now offers a lower return than the KLCI and may experience a series of earnings downgrades by the market over the next few months given the deteriorating outlook for the global economy and CPO price. However, the share price may see some support from its strong dividend yield, costdown initiatives and possible M&A moves.
IOI Corporation Bhd
Valuation and recommendation
Chopping target price and earnings estimates. In line with our CPO price downgrade, we have lowered our earnings forecast for IOI Corp by 21-22% for FY09- 10. In line with the downgrade in our earnings forecasts and target P/E, our target price is scaled back from RM4.60 to RM3.50. We adopt a lower forward PE of 12x instead of 13x to account for the recent downgrade in our target market P/E by one multiple point.
Maintain UNDERPERFORM call. We maintain our UNDERPERFORM call due to the potential downside to target price and its unexciting earnings prospects. We are also concerned about its exposure to the property sector in Singapore and Malaysia as well as potential earnings downgrades by the market. Potential de-rating catalysts include the softer CPO price, lower crude oil price, weaker property earnings and higher-than-expected operating costs.
Kuala Lumpur Kepong Bhd
Valuation and recommendation
Cutting our earnings estimates and target price. We are reducing our earnings forecasts for KL Kepong by 5-33% and have also chopped our target price by 28% from RM11.50 to RM8.30 after applying a lower target P/E of 11x (12x previously) to its plantation unit as well as a 10% discount to KLK’s SOP value. The reduction in the P/E multiple accorded to its plantation unit basically reflects the recent downgrade in our KLCI target market P/E by one multiple point.
Maintain UNDERPERFORM call. There is no change to our UNDERPERFORM call on the stock. We continue to expect KL Kepong to de-rate against the market as the softening CPO price will dampen its earnings prospects. The principal de-rating catalysts are the softening CPO price, declining crude oil price, potential U-turn in biodiesel policy and rising operating costs.
Asiatic Development Bhd
Valuation and recommendation
Cutting earnings forecasts and target price. We are chopping our earnings forecasts for Asiatic by 11-30% for FY08-10 to reflect our CPO price downgrade. In line with the recent downgrade in our target market P/E from 13.1x to 12.1x, we have also lowered our target forward P/E from 10x (based on the stock’s historical 3-year average 12-month forward P/E) to 9x. These two changes combined lead to a downgrade of our target price by 36% from RM5.80 to RM3.70.
Maintain UNDERPERFORM rating. We are keeping our UNDERPERFORM rating due to the unexciting CPO price and earnings prospects. The group’s earnings are sensitive to changes in CPO price as it is a pure planter and sell all its crop on spot basis. Key de-rating catalysts are the softening CPO price, lower crude oil price, higher operating costs and earnings downgrades by the market.
Hap Seng Plantations Holdings
Valuation and recommendation
Cutting EPS forecasts by 11-28%. We are lowering our net profit forecasts for FY1/09-11 by 11-28% to account for the downgrade in our CPO price assumption, lower OER rate and higher operating costs. In line with the earnings downgrade, we are cutting our dividend forecast by 4 sen to 18 sen for FY09 and 2 sen to 22 sen for FY10 and 19 sen for FY11. There is no change to our net dividend payout assumption of 60% for the group.
Maintain UNDERPERFORM with a lower TP of RM1.60. We are lowering our target price from RM2.36 to RM1.60 solely for our earnings downgrade. There is no change to our target P/E rating of 8x, which we recently cut by one multiple after its poor 2Q results. Maintain UNDERPERFORM call, with the key de-rating catalysts being weaker CPO price, rising operating costs and earnings downgrades by the market.
Wilmar International Ltd
Valuation and recommendation
Reducing earnings forecasts and target price to S$3.60. We have cut our earnings forecasts for Wilmar to account for lower CPO price assumptions and minor reductions in our refining profit margins. We also lowered our target P/E to 16x forward earnings from 19x, to account for a lower target P/E for the Singapore market. As a result, our target price falls to S$3.60 from S$4.60.
Maintain Neutral. Wilmar remains a Neutral as it continues to offer potential returns that would match the market’s, in our estimation. Its earnings are the least sensitive to declining CPO prices, among the plantation stocks under our coverage, given that the bulk of its earnings comes from the processing of edible oils and oilseeds. We believe that it deserves to trade at higher P/E valuations than its plantation peers due to its dominant position in the global edible oils market, potential merger synergies, and strong management.
Golden Agri-Resources Ltd
Valuation and recommendation
Maintain Neutral but reducing target price to S$0.42 from S$0.65. We are lowering our EPS forecasts by 5-35% for FY08-11 to account for our lower CPO price assumption and lower corporate tax rate. We have also cut our P/E target for Golden Agri to 9x from 9.5x to factor in the recent de-rating in market P/E. Accordingly, our target price drops from S$0.65 to S$0.42. Our Neutral rating has been maintained.
Indofood Agri Resources
Valuation and recommendation
Lowering earnings estimates and target price. We are slashing our earnings forecasts for Indofood Agri for FY08-10 by 18-42% mainly to account for our CPO price downgrade, lower Indonesian corporate tax rates of 28% for 2009 and 25% for 2010 (from 30% previously) as well as lower cost increases in view of the weaker oil price assumptions.
We have also tagged a lower forward P/E of 9x against 10x previously for Indofood Agri, to account for the recent downgrade in our market P/E target for Indonesia. In total, these have the effect of lowering our target price for Indofood Agri to S$0.90 from S$1.53. The 9x forward P/E is at a 10% discount to the historical 3-year average forward P/E of Indonesian planters due to the increasingly unexciting CPO price prospects.
Maintain Neutral. We are keeping our NEUTRAL rating as the stock is estimated to share similar returns as the market. Indofood Agri’s share price has plummeted the most in the recent sell-down, declining by as much as 76% since the beginning of the year and 71% from the year’s high. As a result, it now trades at a more attractive P/E than its peers. This, however, is partially offset by our concerns about weaker CPO prices and rising operating costs.
Astra Agro Lestari
Valuation and recommendation
Downgraded earnings by 14-40% for FY08-10. On the back of the 12-34% downgrade in our CPO (FOB) price estimates for FY08-10, we have lowered our earnings estimates for Astra Agro by 14% for FY08, 40% for FY09, and 34% for FY10. We have also modelled in lower income tax rates of 28% for FY09 and 25% for FY10 (from 30% previously) as well as lower fertiliser prices and transport costs.
Further de-rating possible; maintain Underperform with lower target price of Rp9,000. We have lowered our target price to Rp9,000, from Rp19,000. Our new target is derived from 8x CY09 P/E (from previously 10x CY09 P/E), a 20% discount to our index target of 10x CY09 P/E. This discount is roughly in line with Astra Agro’s 3- year historical discount to the market, before it started to trade at a premium to the market in Nov 07. Even though the company remains a low-cost producer thanks to its peak-age oil palms, we believe the valuation de-rating could continue amid changes in the CPO price outlook.
London Sumatra
Valuation and recommendation
Earnings downgraded by 13-47% for FY08-10. We have cut our earnings forecasts for Lonsum by 13-47% for FY08-10, on the back of the 12-34% declines in our CPO price estimates.
The company recently hired Goh Cheng Beng, ex-Sampoerna Agro’s CEO who was in charge of Sampoerna Agro’s high-yielding South Sumatra estates. As he brought expertise on plasma plantations, we expect a faster turnaround process in Lonsum’s underperforming South Sumatra estates.
Maintain Underperform with lower target price of Rp2,800. On the back of our earnings downgrade and a lower P/E target of 8x (from previously 10x), we have chopped our target price for Lonsum from Rp6,700 to Rp2,800. Our new P/E is in line with the company’s 3-year historical discount to the market, before it started trading at a premium.
Despite the 58% decline in the stock price since Jul 08, downside risk is 10% from our new target price. Hence, maintain Underperform.
Bakrie Sumatra Plantation
Valuation and recommendation
Earnings downgraded by 14-50% for FY08-10. We have cut our earnings estimates for Bakrie Sumatera by 14-50% for FY08-10, on the back of the cut in our CPO price forecasts. We maintain our rubber price estimates of US$2.60/kg for FY08 and US$2.35/kg for FY09-10.
Maintain Underperform with new TP of Rp400. We have lowered our target price to Rp400 from Rp1,100, after applying a lower 6x CY09 P/E target, from 8x previously. As the company carries balance sheet and operational risk, we assign the company a lower P/E multiple compared to other plantation companies under our coverage. Bakrie Sumatera, to us, is the riskiest of the plantation stocks in Indonesia when CPO prices weaken, mainly due to the fact that excluding Agri BV, around 54% of its estates contain trees 0-5 years old, which translates into high capex, low FFB yields and high costs. The company also has a net gearing of 30%, which increases to 72% if its 51% ownership of Agri BN (with its US$150m of senior secured notes) is included.
Sampoerna Agro
Valuation and recommendation
Cutting earnings by 10-25% for FY08-10. We downgrade our earnings estimates for Sampoerna by 10-25% for FY08-10 to adjust for lower CPO price estimates. We have also accounted for higher seed pricing of Rp8,000/seed for FY09 (previously Rp7,300/seed), up from the Rp4,900/seed forecast we have for FY08. Despite weakening CPO prices, we believe seed pricing should remain good as plantation companies continue to expand their plantation areas.
Among Indonesian plantation companies under our coverage, the earnings cut for Sampoerna Agro is the least, as 50% of its plantation areas consist of plasma which effectively buffers the company during the decline in CPO price.
Maintain Underperform with lower target price of Rp1,750. We have slashed our target price for Sampoerna to Rp1,750 from Rp3,000. We have assigned a lower target of 8x CY09 P/E from 10x previously, inline with the 3-yr average discount the plantation sector have towards market before they traded at premium.
6.United Malacca Berhad,Attractive Valuation. Upgrade to Buy back to topMarket Capitalisation : 830.8
Healthy Growth in 1Q09 Earnings
United Malacca reported higher a higher RM27.5mn net profit in 1Q08, a 38.8% and 60.8% increase on QoQ and YoY basis. After adjusting for exceptional items in 4Q08, including RM8.2m loss arising from disposal of its associate stake in PacificMas, core net profit would have still risen by a decent 16.5% sequentially.
Factors Driving the Growth
The increased earnings was due to, 1) higher average CPO selling price of approximately RM3,500 per tonne, 2) higher FFB production, which increased 27% YoY and 18% QoQ, and 3) higher interest income as cash pile swelled to RM365mn as at the end of the quarter. The company received RM153mn after selling off its stake in PacificMas in the preceding quarter. In addition, we suspect part of the large CPO carry over stocks from 4Q08 has been sold in 1Q09. This was reflected in a RM5.2mn drop in inventory to RM10.9mn.
Bumper FFB Harvest
Management indicated the jump in FFB production was largely due to higher acreage coming into maturity as well as increasing yield, particularly in Sabah which benefited from better estate practices. Mature acreage increased by approximately 900 ha in FY08 and this has been a primary driver to increase in yield. Mature acreage could increase by another 300 - 400 ha this year that would ensure sustainable up-trend in FFB in the next 2 - 3 years, in our view.
Revising Downward Earnings
We cut our earnings forecasts between 8% and 11% after imputing a lower average selling price and mature acreage. FY09 average CPO selling price has been revised downward to RM3,200 from RM3,450 previously in view of the weak prices in the 2Q09, which coincides with peak FFB production period. We have also scaled down mature acreage assumption to 400 ha in FY09 from approximately 700 ha previously to comply with management's estimate.
TP Cut to RM7.60 but Upgrade U. Malacca to Buy
Consequent to the earnings downgrade, we have adjusted United Malacca's target price lower to RM7.60, based on target PER of 10x FY09 EPS. Nonetheless, the stock has fallen to a very attractive level, in our view and trading at 7x - 8x forward PER. Dividend yield too has shot > 8% at current price, and we think there is more upside if management decides to pay excess cash as special dividend. Therefore, we are upgrading the stock a Buy.
7.Leweko: 1HFY08 Results Review ,Going gets tougher back to top
On annualised basis, 1H results were 51% below our expectations. Despite charting positive contributions from its CPO division, this could only help offset losses stemming from its logs and timber products and timber harvesting operations. Weaker earnings in 2Q were mainly due to lower sales volume, lower selling prices (stronger RM against US$) and rising operating costs in regard to its timber operations. We trimmed our estimates to factor in latest weaknesses (lower operating margins and sales volume; timber division), we lower our FY08 and FY09 net earnings projection by 37.9% and 13.8% respectively. Rolling over to FY09 EPS, we also derive a new target price at RM0.36 from RM0.65 (share split adjusted) previously. NEUTRAL recommendation maintained.
Timber stressed. Burdened by weaker sales volume, lower selling price and higher operating cost. Q-o-Q performance saw decline in logs and timber products revenue contributions by 16.8% raking in a loss of RM608k in PBT from RM1.3m previously. Meanwhile, Leweko’s timber harvesting division suffered an operating loss of RM231K. On an YTD basis, timber related divisions (logs and timber products + timber harvesting) incurred a total loss of RM2.2m.
CPO once again the saviour. CPO sales continue to offset losses incurred by its timber divisions. However, weaker FFB (fresh fruit bunches) volume sales has reduced PBT contributions from this division to RM2.9m in 2Q from RM4m in 1Q (-27.6% q-o-q). Going forward, though CPO prices has trended down from a high of RM4500/tonne to RM2500/tonne currently, the group believes as long as prices sustain at its current level, CPO earnings should contribute positively for the rest FY08.
Margins hit. Higher cost base and stronger Ringgit translated to qoq contraction in EBITDA margins from 10.9% to 10.2%. On a net basis, NP margin declined from 5.4% (1QFY08) to 4.6% 2Q.
NEUTRAL, TP at RM0.36. Keeping our NEUTRAL rating on Leweko as the timber sector will remain tough throughout the year, TP is revised downwards to RM0.36 from RM0.65 previously, in light of declining product pricing and higher cost pressures. Valuation is based on an average peers PE of 7.3x pegged at FY09 EPS of 4.9sen.
8.Leweko : results review back to topSummary: Leweko is an integrated timber group with upstream forest concessions and downstream manufacturing of sawn timber, moulded timber and other timber products. The group also owns 998 hectares of oil palm plantations. Analyst: Siti Rudziah Salikin
Market Value - Total: MYR91.7 mln
Results Review & Earnings Outlook
Leweko’s 2Q08 performance remained weak and was behind our expectations. Net profit for the quarter slid to MYR1.2 mln from MYR1.7 mln in 1Q08 and MYR4.8 mln in 2Q07. 1H08 net profit was MYR2.9 mln versus our full-year forecast of MYR6.5 mln
The timber division was impacted by weak demand from Europe (Leweko’s main market), lower selling prices of timber molding products, and its full dependency on log supply from third parties. It recorded a loss of MYR2.2 mln in 1H08 compared with a profit of MYR9.6 mln in 1H07.
The plantation division disappointed us with a 27.4% QoQ drop in 2Q08 operating profit as higher palm oil prices were offset by lower FFB output and increased production costs. The profit was still higher YoY. Operating profit for 1H08 surged 2.2x YoY to MYR6.9 mln.
Leweko resumed third party log harvesting works in late June 2008, which should help to improve the timber division’s performance in 2H. However, the plantation division will feel the effect of lower palm oil prices in the 2H.
We cut our earnings forecast for the plantation division but after factoring in contributions from the log harvesting contract, we keep 2008 net profit unchanged at MYR6.5 mln and raise 2009 profit by 6.8% to MYR6.3 mln.
Recommendation & Investment Risks
We maintain our Hold recommendation on Leweko despite the recent share price correction, which increases the potential upside to the share price to 28.9%.
The prospects of demand recovery and earnings outlook for the downstream timber operations remain uncertain, which could drag the share price performance, in our opinion. The palm oil slide will also hamper the prospects of the plantation division, which is currently the earnings savior.
The target price is based on an unchanged 40% discount (to reflect the uncertain prospect of recovery) to our projected NTA for 2008.
Leweko is expanding into timber flooring production through its proposed acquisition of 51% stake in SCK Wooden Industries Sdn Bhd. We believe the acquisition, which is targeted for completion in 4Q08, will be accretive to Leweko’s earnings. However, the net impact (after factoring in the consolidation of SCK’s borrowings of MYR7.0 mln) could turn out to be small. We have not factored in the impact of the acquisition into our forecast.
Risks to our recommendation and target price include: (i) a prolonged downturn in the housing markets in Europe and the U.S., which will delay the recovery of demand for Leweko’s downstream timber products; and (ii) a continued downtrend in palm oil prices.
9.Sarawak Plantation : Results Note ,1H08 slightly lower back to top
1H08 net profit of RM28.8m was lower at only 29% of our forecast and consensus respectively. Lower 1H08 was mainly attributed to higher production costs and CPO spillage caused by a damaged tank.
QoQ, 2Q08 revenue and pre-tax jumped 63.3% and 62.8% respectively on higher average selling CPO price of RM3,536/MT (+16.6%) vs RM3,033/MT in 1Q08. A stock loss of RM6.9m was also registered in 2Q08 as a result CPO spillage due to a damaged tank. Management is confident that group will be able to recover most of the loss through insurance claim.
YoY, 1H08 revenue rose 48.5% courtesy to higher average CPO price . Pre-tax growth however was lower at 35.8% due to increase in fuel and fertilizer costs coupled with the imposition of cooking stabilisation cess introduced since June 2007.
Commodities tumbled! CPO future experienced a 40.4% plunge from the peak of RM4330/MT in March 2008 to RM2 580/MT at the time of writing coinciding with the slump of crude oil price. Accordingly we have also lowered our FY08 and FY09 CPO price assumptions to RM2,900/MT and RM2,500/MT respectively from the previous RM3100/MT.
Lowering our net profit forecasts by 14.1% and 35.8% respectively after adjusting for our lower CPO price assumptions. Risks to our forecasts include lower than expected CPO price and rising production cost.
Downgrade to HOLD. Target price reduced to RM2.70 based on a lower FY08 PER of 9x as the plantation sector had been de-rated subsequent to the sharp CPO price correction.
10.SOP : Enters into JV to develop 14,500 ha of land back to topSarawak Oil Palms (SOP) has entered into joint venture agreement (JV) with Pelita Holdings Sdn Bhd to develop 14,500 ha of land in Sri Aman, Sarawak. Out of the 14,500 ha of land, approximately 8,000 ha are plantable into oil palm plantations. The proposed JV is expected to be completed in 4Q2008.
SOP’s equity interest in the JV is 60% while Pelita Holdings’ share is 10%. The balance 30% shareholding will be held under natives customary rights. Pelita Holdings is a subsidiary of Land Custody and Development Authority of Sarawak and one of SOP’s major shareholders. Pelita Holdings holds a 26% equity interest in SOP.
At the same time while this JV is being inked, SOP and Pelita Holdings has rescinded a joint venture involving 1,250 ha of land in Miri, Sarawak.
Entering into JVs with the Sarawak State Government is one of the ways how plantation companies expand their landbank in Sarawak. Recall that in early August this year, IOI Corporation had also entered into a joint venture agreement with Pelita Holdings Sdn Bhd to develop 7,000 ha of land in Sibu.
We view the JV to develop 14,500 ha of land in Sarawak positively as it would increase SOP’s landbank. Currently, we estimate SOP’s landbank at 55,851 ha.
Including the new JV and excluding the rescission of the JV to develop 1,250 ha of land, SOP’s landbank would be about 69,101 ha. This would make SOP almost as large as Kulim Bhd, which has approximately 82,906 ha of landbank in Malaysia, Papua New Guinea and Solomon Islands.
SOP’s cash subscription for its equity portion of the JV is about RM11.5mil in total. Based on SOP’s 60% equity interest, the consideration would translate into roughly RM1,324/ha.
We do not expect immediate contribution from the new landbank under the JV as it would take about three years for oil palm trees to bear fruit. Plantation development expenditure is expected to be between RM10,000/ha to RM13,000/ha. Nevertheless, the expansion of SOP’s landbank would help sustain CPO production and profitability in the future.
Despite this positive development, we maintain a SELL on SOP as CPO prices are expected to come under pressure from softening crude oil prices and a supply imbalance situation.
11.QL : 1Q RESULTS UDPATE for FYE09 back to topMarket Capitalisation : RM 897.4
1. 1Q FY09 Results – in line with expectations
Y-o-Y Revenue and net profit during 1Q was up 16% and 40% respectively against our full year forecast for same of + 13% and 8% respectively. The 1st quarter results capture the peak of the uptrend in commodity prices during the period.
Quarterly comparison reflects the impact of seasonal factors – where in the 4th Quarter the Marine Products Manufacture and the CPO milling divisions were affected by the monsoon. Also, at the Integrated Livestock Farming division there was reduced trading in animal feed raw material because of the volatile price movements during the period.
Y-o-Y, overall margins continue to show steady, albeit slight, improvements. The main improvement came from the higher sales and higher profitability at the Marine Products Manufacture and higher trading profits at the Integrated Livestock Farming division.
At the balance sheet net gearing is maintained at above 70% of equity, whilst (annualized) ROE remains respectably above 20%. Given the pretax margin on sales of below 10%, the company continues to demonstrate good financial acumen in the management of capital.
Outlook
This year there will be a maiden contribution from 3000ha just matured oil palm plantation out of the 20,000ha total acreage. Thus in addition to milling income, there will be profits from sales of CPO from its own plantation.
The weakening prices across the whole spectrum of commodities could either be indicative of the onset of a global recession or a reflection of an increasing price volatility that is the consequence of the integration of the commodities markets into the global financial investment portfolios.
We are retaining our original full year forecast for a revenue increase of 13% and net profit to grow by 8%. Based on the 1Q results, this implies that for the rest of the year we expect revenue and net profit to increase by a much lower rate than was achieved in the 1Q.
We expect the continuing growth at the marine products division to be somewhat mitigated by lower CPO prices and a more subdued trading environment for the integrated livestock farming division.
2. Recommendation
QL has again demonstrated its execution ability in pursuit of its clear and defined business objectives. Its programmed expansion appears to be on track with no unpleasant-surprises or negative side effects on earnings.
By maintaining our PER of 13x we are, on a relative valuation basis, upgrading QL against the overall market. This translates to a fair value of RM3.62 - a potential 30+% upside from the current level, we are maintaining QL as BUY.
12.QL:Company visit,Sets out next chapter of growth back to top
Investment Highlights
We are reiterating our BUY recommendation on QL Resources (QL) with an unchanged target price of RM3.43/share, after rolling our base year to 2009 and pegging revised earnings at a PE of 11x.
QL’s marine-based division is set to continue to enjoy pricing power amid critical shortage of fish supply globally. Earnings growth is expected to remain intact, buoyed by unwavering demand for surimi and surimi-based products, while margins could improve on the back of higher selling prices to pass on increased operating costs, namely fuel. We have forecast contributions to grow by 10% in FY09F and a stronger 18% in FY10F.
Additional capacity will come from its new Surabaya plant (capacity: 5,000 tonnes p.a.), which will be operational as early as April 2009. Management is also evaluating a JV to set up a surimi manufacturing plant in Sarawak.
Earnings from the integrated livestock division will be underpinned by Heap Loong Poultry Farm acquisition and its Vietnam egg-farming venture. QL’s egg production will total 3 million/day by mid-FY11F, when its Vietnam farm posts its maiden contribution. To reflect these positive expansions, we have forecast margin improvement (FY09F: Y0Y +2 pts, FY10F: YoY +5pts) on the back of integration benefits arising from consolidation of its egg farms.
Earnings from QL’s oil palm division will continue to be small until FY12F when its 20,000-hectare Kalimantan palm oil estate matures. Planting is well on track, with 7,000 hectares covered with seedlings. We have forecast margins for the oil palm division to be slightly lower at 5% for FY09F due to stiff competition among millers.
Going forward, QL is expected to deliver earnings CAGR of 20% for FY09F-FY11F, with growth driven by its expansion plans, both locally and abroad. We have revised upwards our EPS forecasts by 17% and 23% for FY09F and FY10F to 29.8 sen and 35.9 sen, respectively. Dividend payout policy of 25%- 30% is clear and unchanged and we expect dividends to improve from 6.5 sen in FY08 to 8.5 sen and 10.5 sen for the two years respectively.
We remain impressed with QL’s consistent YoY performance in each of its sectors (marine-based products, integrated livestock farming and oil palm division). At a target price of RM3.43/ share, QL trades at a PE of 11x FY09F earnings, in line to current market PE of 11x. Backed by strong underlying fundamentals and favourable food industry drivers, all its three divisions are poised to sustain positive earnings momentum going forward. QL looks set to write the next chapter of growth - BUY.
REITERATE BUY, STOCK OFFERS 28% UPSIDE
We reiterate our BUY recommendation on QL at an unchanged target price of RM3.43/share, based on revised PE of 11x FY09F earnings. We have raised earnings forecast by 17%-23% for FY09F-10F to account for QL’s positive earnings outlook on the back of a steady expansion drive in ensuring sustainable growth going forward.
At the price of RM2.67/share, our target price suggests 28% upside potential, with plenty of room for appreciation. Further upside for the stock could come from acquisition or takeover of rivals, namely competitors to its integrated livestock farming division, which is currently saturated with small players and ripe for consolidation. Notwithstanding this, a stronger CPO price could potentially push earnings forecasts upwards, and thus a re-rating by the market accordingly.
MARINE PRODUCTS - DEMAND REMAINS RESILIENT
Higher fuel costs
Price of diesel now costs RM1.43/litre compared to RM1/litre previously. Despite higher fuel costs, marine products manufacturing remains the most profitable division (See Diagram 1). Diesel could easily make up to 70%-80% of total costs to fishermen in powering their boat engines but the impact of higher fuel costs have been lower, thanks in part to the rebate scheme introduced by the government.
Under the scheme, fishermen has a choice to either choose to receive a subsidy of RM100 per tonne of fish caught or opt for a RM200 cash per month. Therefore, the effective increase in operating costs has been lowered by approximately 15%.
...but offset by higher selling prices
The division has enjoyed firm demand for surimi and surimi-based products. Surimi prices have increased by more than 50% since 2007, with demand continuing to outstrip supply. We believe this trend is likely to continue given global shortage of fish used for surimi and still-strong consumer sentiment from major export markets of Japan, South Korea and Singapore. This augurs well for QL as over 38% of the group’s earnings come from this division alone (See Diagram 1).
New markets and more efficient plants
Looking ahead, the versatility of surimi and opening of new markets should ensure a sound underlying demand for the products in the next few years. QL will be constructing a surimi manufacturing plant in Surabaya, Indonesia as part of its capacity expansion drive to secure its supply of fishes. To be built at US$8mil, contruction is scheduled to begin in December 2008 with a commercial run expected to be as early as 2010.
QL’s management has allocated RM100mil for FY09F and FY10F to upgrade factory operations, conversion of its Kota Kinabalu fishmeal processing plant from diesel to biomass as well as building of deep sea vessels as part of its fleet expansion. Both its Perak and Johor plants are currently running on biomass, giving the group a competitive cost-savings advantage over its other less efficient competitors.
INTEGRATED LIVESTOCK FARMING - MAY SURPASS MARINE PRODUCTS
To benefit from lower commodity prices
QL Resources’s integrated livestock farming division has performed better than expected. The division, which saw profit growth of 37% in FY08, is expected to sustain double digit growth over the next two years. Though corn and soyabean price pressures have eased, the benefits may be offset by a weaker RM/US$ exchange rate since these imported commodities are key ingredients to producing feedmeal (See Diagram 3 and 4). However, being an integrated player means QL’s egg farming operations would stand to benefit from the lower production costs.
In a worst case scenario, should corn and soyabean prices climb back north, earnings from both feedmeal and egg farming should remain intact given the inelastic demand and ability to pass on increase in costs.
More eggs on the way...
QL’s recent acquisition of Heap Loong Poultry Farm (Kulim, Kedah) enables it to increase capacity and boost its egg production by 400,000/day to 2 million/day. Assuming a net profit margin of 10%, total contribution to the group’s net profit could potentially increase by RM2.6mil a year.
Additionally, a substantial portion of the group’s future earnings will come from its Vietnam farming venture (Tay Ninh, Ho Chi Minh). At a cost of RM60mil with commercial runs set in mid-2010, the integrated egg farm exudes great potential given the higher margins and the early stage the industry is currently at in Vietnam.
Better margins in Vietnam
Going forward, we expect contributions to increase given QL’s available capacity to produce up to 800,000 eggs/day for the first two years of production as well as higher average selling prices and margins. The average selling price in Vietnam is higher at 50 sen/egg compared to Malaysia’s 30 sen/egg. Margins in Vietnam are approximately 3-4 sen/egg, slighly higher than the 2 sen to 3 sen achievable in Malaysia.
The fully integrated farm will feature breeder farms, feed milling and egg farming, similar to its efficient Malaysian model. The group has allocated a sum of RM120mil for FY09F and FY10F for its Vietnam venture and plans to increase production capacity in integrated farming in East Malaysia as well. It continues to lead in Sabah with a market share of over 60%.
OIL PALM DIVISION - SMALL BUT PLANTING ON TRACK
Competition remains stiff
Despite high CPO prices, performance of its oil palm division have been lower than expected, with profit for FY08 increasing by a mere 6% to RM10mil, on the back of RM302mil revenue (YoY +40%). Based solely on oil palm milling activities, the division’s small contribution was a consequence of unfavourable weather conditions (La Nina phenomenon) in East Malaysia that resulted in a low oil extraction rate, coupled with razor-thin margins due to stiff competition for FFB supplies.
On a more positive note, based on our estimates (CPO price: RM2,200 per tonne) the group is expected to recognize billings equivalent to approximately RM9mil profits from its own 3,000 acres of plantation in in Sabah for FY09F. However, we believe EBITDA margin will be quite flat at 4%-5%, given our bearish outlook on CPO prices and high fertilizer costs.
...but long term prospect remains bright
Over the medium to longer term however, outlook for the oil palm division remains bright. Progress of its 37,000 acres (20,000 hectares) of Indonesian plantation is well on track with 7,000 acres of greenfield planted with seedling as at 30 June 2008. The group has targeted 10,000 acres for planting in each financial year. As such, we have forecast earnings from this division to remain small throughout FY09F and FY11F before the oil palm plantation matures in FY12F. By then, the division will generate no less than RM90mil in additional revenue per year.
FINANCIALS
Capex on the rise
Over the next two years (FY09F and FY10F), management has allocated a total of RM170mil per annum for capital expenditure (capex). Of the total, RM50mil has been earmarked for marine-based division and RM60mil allocated to the integrated livestock division, while the remaining RM60mil will go to palm oil division. Given the size of its capex budget, we do not rule out further acquisition of rival companies in the near future as the group steps up effort to better reposition itself as a bigger player.
Gearing at comfortable level
Financing will not pose a major difficulty as QL is able to generate an average free cash flow of RM150mil every year. We are not overly concerned with the group’s net gearing level of approximately 70% as the borrowings have been instrumental to the group’s business growth and provided strong leverage to earnings, which explains the high ROEs of around 20% per annum. Interest coverage is good at 9x with close to half of the borrowings in short term debts.
Earnings forecast raised, dividend payouts of 25%-30% stays
Reflecting the solid revenue growth, we have revised upwards our EPS forecasts by 17%-23% to 29.8 sen and 35.9 sen for FY09F and FY10F, respectively. Although dividend payout ratio of between 25%-30% is never a written policy, QL has been maintaining that level of profit distribution to shareholders despite its expansion phase. QL’s management has reaffirmed this would continue going forward. We have raised our DPS outlook in tandem with higher earnings for FY09F and FY10F to 8.5 sen and 10.5 sen (See Diagram 5).
VALUATION & RECOMMENDATION
BUY at same target price of RM3.43
We reiterate our BUY recommendation on QL at the same target price of RM3.43/ share. Our target price encapsulates the rolling of our base year from 2008 to 2009 and pegging FY09F earnings at a PE of 11x. We deem the valuation fair given that PE of 11x is close to the stock’s mean PE of 11.5x (See Diagram 6) over the last three years and in line to current market PE of 11x. The consumer sector PE stands at 14x currently.
Backed by favourable industry drivers and strong underlying fundamentals, we remain confident all its three divisions are poised to sustain positive earnings momentum going forward. Led by a sound and prudent management team, QL looks set to write the next chapter of growth. BUY.
13.Kulim (M) 1HFY08 Results, Seasonally Weaker back to top
Kulim’s 2Q earnings were seasonally weaker as Malaysia’s FFB production dipped while undelivered oil from 50.5%-owned New Britain also dampened earnings. Nevertheless, these are temporary issues and should normalise in 3Q as Malaysia’s plantation segment recovers. Our lower target price of RM11.80 has accounted for New Britain’s stock price at 3.30 sterling pounds. Kulim remains one of the most undervalued plantation stocks, with implied value of its Malaysian operation at under 5x forward earnings.
Below expectation. Kulim’s annualised 1H results were 8.5% below our full-year forecast of RM411.2m and 12.3% below consensus estimate. The lower-than-expected results were due to:
1. seasonally weaker Malaysia FFB production (-11.5% q-o-q).
2. undelivered oil from Papua New Guinea at end-June, as reflected in the 28% jump in inventory q-o-q.
The earnings were lower than expected despite the stronger-than-expected manufacturing earnings, making up 71% of our full year forecast. We are not overly concerned as the shortfall is minimal, which we believe will be made up in the remaining quarters.
Rising average CPO price. Kulim’s Malaysia plantation segment recorded an average CPO price of RM2,787 for 1H, compared with RM2,641 for 1Q, reflecting the diminishing impact of its low price forward sale. Hence, its 3Q CPO price should get nearer to the MPOB average.
Maintaining forecast and target price. We have recently toned down our CPO price assumption from RM3,500 to RM3,150 for CY08 and RM3,200 to RM2,800 for CY09. Consequently, the ’08 and ’09 net earnings forecasts for Kulim have been toned down to RM411.2m and RM385.4m respectively. The impact of the acquisition of Sindora at end- April has a minuscule effect on Kulim’s performance.
KEY HIGHLIGHTS
OSK Research Guide to Investment Ratings
Buy: Share price may exceed 10% over the next 12 months
Trading Buy: Share price may exceed 15% over the next 3 months, however longer-term outlook remains uncertain
Neutral: Share price may fall within the range of +/- 10% over the next 12 months
Take Profit: Target price has been attained. Look to accumulate at lower levels
Sell: Share price may fall by more than 10% over the next 12 months
Not Rated: Stock is not within regular research coverage
14.CCM : Initiating Coverage ,Getting the Chemistry Right back to topCCM is without doubt the industry leader given its competitive advantage and expertise. The Group’s pole position in the industry gives it great bargaining power in terms of securing raw materials, selling prices and economies of scale. The stock offers indirect exposure to the buoyant agricultural commodity sector and the region’s growing pharmaceutical sector. We initiate coverage on CCM with a BUY call and a target price of RM3.26 based on a DCF model at an 8.3% discount rate. The company consistently pays good dividends and boasts of yields of more than 5.5%.
Solid market position. Having divisions that are market leaders in fertiliser, chemical and pharmaceutical segments puts CCM in pole position, which also gives it great competitive advantage in the industry. The emergence of PNB as the group’s largest shareholder has strengthened its profile, especially its fertiliser division, given PNB’s substantial shareholdings in oil palm plantations in Malaysia.
Favourable industry outlook. The Group through its fertiliser division offers indirect exposure to the buoyant agricultural commodity sector, particularly the palm oil sector. Growing health awareness among the population is expected to support steady growth in the local and regional pharmaceutical sector. The reshaping of its chemical division from producing mass market products towards specialist chemical, especially via the acquisition of Innovative Group, is expected to strengthen its position in the niche market segment.
Potential M&A. Although the much talked about M&A with Pharmaniaga remains a rumour, we cannot discount this possibility, which could result in further consolidation in the pharmaceutical industry and possibly, the emergence of a national champion that will be able to compete with global MNCs.
Initiate with BUY. We are projecting for topline to grow around 18%-20% for 2008 and 2009 and bottomline to expand 17%-19%. The full impact of the acquisitions of Enersave and Innovate Group will be felt in 2009 onwards. We initiate coverage on CCM with a BUY call and a target price of RM3.26 based on a DCF model and at a discount rate of 8.3%. We view CCM as a defensive long term investment with steady dividend yield and well supported expansion strategy.
COMPANY OVERVIEW
Background. CCM was incorporated as Chemical Company of Malaysia in 1963 by Imperial Chemical Company Plc (ICI) of the United Kingdom. It was initially set up to manufacture chlor-alkali products and high-grade compound fertilisers. In 1995, the company broadened its horizon to include pharmaceuticals and hospital services. At present, its main core business is in the manufacture and marketing of fertilisers, chlor-alkali, pharmaceuticals and healthcare products. Its core business comprises three main divisions – the fertiliser, chemicals and pharmaceuticals divisions.
Malaysia’s largest fertiliser player. CCM’s involvement in the fertiliser industry is via its 50.1%- shareholding in CCM Fertilisers SB (CCMF), which is the largest manufacturer and trader of fertilisers in Malaysia with a 30% share of the local market. In 2007, the fertiliser division contributed around 51.9% of Group revenue. CCMF is the only manufacturer of compound fertilisers in the country, and boasts of quality certifications from Sirim and the International Standards Organisation (ISO). At present, CCMF has only one fully operational plant in Shah Alam with an annual rated capacity of 280,000 tonnes, plus three plants – in Bintulu, Medan and Lahad Datu – currently under construction. Upon the completion of the 3 new plants, CCMF will have a combined capacity of 670,000 tonnes of fertilisers per annum, making it one of the largest producers of compound fertilisers in Asean.
Major water treatment player. CCM’s involvement in chemicals is via its 80%-owned subsidiary CCM Chemicals SB (CCM Chemicals). The division’s principal activities include the manufacture and marketing of chlor-alkali and other chemical products with 3 manufacturing facilities located in Shah Alam, Port Klang and Pasir Gudang, producing and formulating various chemical products. The 2 major products produced by CCM Chemicals are chlorine and caustic soda. Chlorine products are typically used for water treatment and in plastic manufacturing while caustic soda is used in the manufacture of soap powder, alumina, detergents and bleaching products, as well as in the pulp and paper industry. In 2007, the chemicals division contributed around 32.7% of group revenue. Riding on its established position in Malaysia, CCM Chemicals is progressively penetrating the Asean market by setting up offices in Singapore, Indonesia, Vietnam, Thailand and the Philippines.
Largest manufacturer of health supplements. CCM’s pharmaceuticals division comprises several subsidiaries such as CCM Pharma SB, UPHA Pharmaceutical Manufacturing SB and CCM Duopharma. This division is mainly involved in manufacturing and marketing pharmaceutical and healthcare products. Around 80% of the pharmaceutical products are ethical products and the remaining 20%, OTC products. Currently, the division exports to more than 20 countries worldwide, with Asian countries such as Cambodia, Indonesia, Hong Kong and Singapore being the major export markets. In 2007, the pharmaceutical division contributed around 15.6% of Group revenue.
KEY HIGHLIGHTS
Favourable industry outlook. According to the Department of Statistics, between 2003 and 2007, the sales value of chemicals increased at an average annual rate of 20.5% compared with a growth of 9.1% to RM157.9bn in 2007. Over the same period, the annual export value of chemicals rose 15.3% to RM36.4bn in 2007. The fertilisers division, the group’s biggest revenue contributor, is expected to remain so given the country’s focus on the agriculture sector, thanks to the current food crisis and the boom in the plantation sector. CCM’s pharmaceutical division, which is the largest manufacturer of health supplements and medicines, is expected to grow steadily supported by rising healthcare expenditure and growing awareness of healthcare and disease prevention among the population.
Market leader. With its divisions being the largest in their respective segments and their dominant market share, CCM will remain a market leader that has the strong competitive advantage, and vast experience and in-depth knowledge on the industry. Its strong market position means CCM has bargaining power in terms of securing raw materials, selling prices and economies of scale. The emergence of PNB as the group’s largest shareholder has strengthened its profile, particularly its fertiliser division, given PNB’s substantial shareholdings in plantation estates in Malaysia.
FERTILISER DIVISION
Capacity expansion to accelerate growth. With its sole plant in Shah Alam running at near full capacity of 280,000 tonnes per annum, the company has had to contract out orders to other manufacturers and to a certain extent turn down orders and potential sales due to capacity constraints. To overcome these constraints, CCM is investing around RM150m in three new plants, in Bintulu, Sarawak; Lahad Datu, Sabah and Medan in Indonesia, which will raise CCMF’s production capacity by 390,000 tonnes. The Bintulu plant is expected to be fully operational by 2H08 while the Medan and Lahad Datu plants are expected to be fully operational in 2009 and 2010 respectively. Upon the completion of the three new plants in 2010, CCMF will have a total annual capacity of 670,000 tonnes, which will make it one of the largest manufacturers of compound fertilisers in Asean. We believe with the capacity increase, CCM will be able to expand its market share locally and internationally, and benefit from economies of scale.
Leveraging on plantation sector. With around 80% of CCMF’s products catering to the palm oil industry; the health of this sector is crucial to the fertiliser division. Firm CPO prices have boosted the demand for fertilisers as farmers and oil palm plantations attempt to raise yields to capitalise on the crop’s high prices. Compound fertilisers sales generally move in tandem with movements in CPO price, although with some time lag. Typically, during a CPO price down-cycle, farmers and planters tend to switch to cheaper alternatives such as straights, mixtures and lower nutrient compounds. In September ‘07, due to rising raw material costs, CCMF raised the selling prices of its compound fertilisers by 15% but the demand from palm oil planters still grew. There might be some concerns over the possibility for palm oil players switching to cheaper and lower quality fertilisers given the current downtrend in CPO prices. However, we believe the demand for CCMF’s products will remain steady supported by its strong clients profile and the narrowing the price gap between compound and alternative fertilisers. However, we are conservatively assuming lower selling prices for compound fertilisers in 2009 and 2010 given the weakening in CPO prices.
Benefiting from food crisis. Currently, the world is facing a global food crisis whereby the shortage of food caused by rising demand and lower crop yield due to climate changes have pushed up food prices. To tackle this shortage, every country would have to increase food production by boosting their agriculture sectors. Due to limited land for agriculture, most countries have to increase food production either by improving the genetic make-up of plants and also through use of better fertilisers to boost crop yields. Locally the government has been encouraging farmers to increase food production, especially rice, and has shown its commitment by setting up a special fund to boost food production. This has resulted in higher demand for CCMF’s products since it also caters to fruit, vegetable and paddy farming. The management believes fertilisers will play a significant role in the company’s growth since there is a growing need to boost food production to meet rising demand and safeguard social and national interests. The management said the current period is the best of times for the fertilisers business.
Securing raw materials via strategic alliances. Around 90% of the raw materials used by CCMF is imported. For instance, ammonia is imported from Indonesia while potash is from Jordan, Germany and Russia. This high dependence on imported raw materials exposes the company to global supply risks that will negatively affect its fertiliser business. To reduce the risk in securing raw materials, typically CCMF’s contracts are negotiated in advance whereby quantities are specified and spot prices are quoted before delivery. Recently, the company entered into a strategic alliance with The Arab Potash Company to guarantee security in the supply of muriate of potash (MOP), or potassium chloride, to ensure the smooth running of its fertilisers division. CCM is also looking for strategic partnerships for the supply of urea to its upcoming plant in Medan.
Mitigating rising costs. In the light of rising raw materials and energy prices, CCMF is actively looking for alternatives to increase cost efficiency by undertaking several measures. To reduce the cost of maintenance and servicing at its existing plant in Shah Alam, CCMF is allocating RM25m to convert the plant to use a safer and lower cost urea-based steam granulation process technology from the current ammonium nitratebased process. The conversion is planned for the final quarter of 2008 and when completed will allow CCMF to reduce plant maintenance and servicing costs and eliminate logistics and handling costs for liquid ammonia. On anticipation of energy costs going up, CCMF had a few years ago moved from using diesel power to gas. According to the management, although gas prices have gone up it is not as high as diesel price. CCMF also switched from ammonia-based fertilisers to urea-based ones as it costs more to handle and transport ammonia compared with urea. Cost cutting is also being implemented by building plants in east Malaysia to be closer to its markets and to scale back shipping costs.
CHEMICALS DIVISION
Solid market position. CCM Chemicals has been producing chlorine in the last 35 years. It is one of only two chlorine producers in Malaysia, with the other being Malay-Sino Chemicals Industry (MS). Each player respectively supplies 50% of the requirements of water treatment plants in Malaysia. Both players focus on their own niche market segments according to their respective geographical channels. Basically, CCM Chemicals dominates the central and southern regions of Peninsular Malaysia while Malay-Sino serves the east coast and northern region. This has enables both players to reduce their transportation costs and also facilitate and expedite delivery. Being in a duopolistic market, the company is in a solid position given the industry’s prohibitive entry barriers and limited domestic demand. The intense competition in the industry has been mitigated by the protective nature of the industry and the difficulty in transporting liquefied chlorine, which requires a high level of expertise.
Acquisitions propel growth. The group further strengthened its presence in the watercare sector via the acquisition of a 97% stake in Enersave Water SB for RM38.3m early this year. We believe the acquisition will expand the group’s offering of watercare solutions to include physical water treatment technology in the clean water and waste water sectors. In line with its mission to strengthen the reputation of CCM’s rubber chemical business, the group has entered a conditional SPA to acquire a 94% stake in polymer coating solutions specialist, Innovative Group of Companies. We believe this acquisition will solidify its position as a supplier of speciality chemicals to manufacturers of powder-free rubber gloves and enable it to tap the robust growth in the country’s rubber and latex industry.
Penetrating regional markets. Riding on its established market position in Malaysia, the group has been progressively expanding its export markets by penetrating regional countries such as Singapore, Vietnam, Indonesia and Thailand. Its subsidiaries in Singapore and Indonesia recorded impressive turnover in 2007 while its Vietnam subsidiary performed well in line with expectation. To further capitalise on the robust growth in Indonesia’s industrial sector, the group expanded its product portfolio to cater to a bigger market segment. Meanwhile, in Vietnam, the group has secured new agencies in speciality chemicals to extend its geographical coverage. And in line with the group’s regional expansion strategy, the group will continue to actively explore potential acquisitions and joint venture opportunities in the region to ensure sustainable growth. We believe the group’s strategy to expand its overseas markets will reduce its dependence on the local market and diversify its portfolio.
PHARMACEUTICALS DIVISION
The largest in Malaysia. With over 280 products in its portfolio, CCM Pharmaceuticals is the largest manufacturer of generic drugs in Malaysia. In the past few years, the group had been aggressively expanding its pharmaceuticals division via acquisitions. It bought Duopharma in 2006 and Malayan Pharmaceuticals in 2007. The pharmaceuticals division has launched six new ethical products and two OTC products, and relaunched two existing OTC products in 2007. Apart from looking at drugs that are coming off patent, the group is also exploring the potential in the herbal market and expects to produce more herbal based products in the near future. We believe its wide product portfolio provides diversification and a larger market for the pharmaceuticals division.
Steady growth in pharmaceuticals sector. Malaysia’s pharmaceutical sector is expected to grow at a steady 8% to 12% per annum over the next few years. The market for OTC products has expanded in tandem with rising consumer awareness on the importance of good health and alternative medicines. Meanwhile, the market for generic drugs is expected to expand at double digits for the next few years supported by the expiry of patents for blockbuster drugs, rising healthcare costs and drug prices, and various cost-containment measures by the governments across the globe. We believe that the positive outlook for the sector provides ample opportunities for the pharmaceuticals division to sustain its growth momentum.
Export expansion. CCM Pharmaceuticals exports to more than 20 countries, with exports accounting for less than 10% of total sales. Singapore and Hong Kong are its largest export markets. In expanding its overseas market base, the group is actively looking towards the Middle East and Africa as potential markets. It also hopes to penetrate into the European and US markets supported by Malaysia’s membership in the European Pharmaceutical Inspection Co-operation Scheme (PICS), whereby the approval process is expected to be shortened. Apart from new markets, the group is also strengthening its presence in the existing export markets and enhancing its distribution channels. It is also actively looking for potential acquisitions in the Asean region, especially Indonesia, and is willing to spend US$40m to US$50m on potential acquisitions. To further capitalise on Indonesia’s huge market potential, the Group needs to acquire a local company in Indonesia owing to the country’s localising policy.
Tapping halal market. Apart from geographical expansion, the group is also expanding into the halal segment with Indonesia being the pioneer market for its halal products. At present, sales of its pharmaceutical products to Muslim countries already contributes 20% of total exports, which the group aims to increase to more than 40%. The global Islamic consumer market valued at around US$580bn with a population of more than 1.6bn people. Having obtained halal certification, a Halal Council was set up at the group level to maintain and safeguard halal standards. We believe that the group is moving in the right direction to tap the potential of the halal market. We agree with the management that in order to exploit the potential in this segment, a lot needs to be done, especially in terms of awareness and education, since we are still at the early stages of developing this segment internationally.
Size does matter. In an ultra competitive environment, cost efficiency plays an important role in a company’s competitive edge. Being among the largest manufacturers of healthcare products with an integrated business model, CCM’s market leading position gives it the advantage of economies of scale and strong bargaining power, especially in the light of rising material prices. The management, through its integrated business model, has been able to streamline and synergise its pharmaceuticals division, particularly in terms of securing raw materials, R&D and also marketing activities. In order to fully utilise group synergies, CCM is unifying and rationalising its pharmaceutical division by streamlining its marketing and R&D activities. It has opened a new state-of-the-art R&D centre in Glenmarie which commenced operation in April this year. The centre has GLP and ISO 17025 certification and is equipped with the latest laboratory technology. We view this as an important step for the group towards strengthening its pharmaceutical division to keep its competition edge through aggressive R&D activities and product innovation.
Potential M&A with Pharmaniaga? There have been rumours of PNB and Khazanah Nasional discussing the possible sale of Pharmaniaga to CCM Group. Although this is just a rumour, we cannot ignore the possibility of Khazanah disposing of Pharmaniaga from UEM Group, in line with the restructuring and streamlining of the latter company’s core businesses. Should that happen, we believe CCM would certainly be the best candidate for the potential M&A with Pharmaniaga, given that both are in the pharmaceutical business. If the rumour does come true, we are positive on this M&A, which will result in the formation of the country’s biggest pharmaceuticals company, or possibly a national champion. This is in line with the view expressed in our healthcare sector report that there is a need to consolidate pharmaceutical players to achieve greater economies of scale and level the playing field vis-à-vis the large MNCs locally and internationally. We wish to reiterate our view that unification of the pharmaceutical industry will give our local players a larger pool of resources in order to engage in more advanced R&D activities and to have a greater market power, which would in turn help our players penetrate the high value patented products segment.
KEY RISKS
Rising raw material prices. Soaring prices of materials such as active ingredients and basic chemical formulations plus rising energy costs will erode CCM’s margins, as we are already seeing margin erosion in its chemicals and pharmaceuticals divisions in the last few quarters. Although its fertilisers division has generally been able to pass on cost increases to its consumers given the buoyant agriculture sector, there are some concerns over margins during a less than favourable cycle in the agriculture sector as farmers tend to switch from relatively expensive compound fertilisers to cheaper alternatives. With global inflationary pressures expected to remain high, we foresee uncertainty for the industry in general, with the possibility of further margin erosion. Although the group is implementing cost efficiency measures, we believe there is a limitation to mitigating the rising costs since raw material prices are expected to continue to go up for the next few quarters due to a shortage of supply. Basically the shortage of available supply does not necessarily translate into scarcity of resources since these resources are not immediately available as considerable time and large investments are required in order to access and develop economic reserves.
Commodities cycle. As we mentioned before, the group’s fertilisers division is highly dependent on the commodity cycle, particularly the movement in CPO prices, since 80% of its fertiliser products cater to the palm oil plantation sector. CCM’s heavy dependence on the palm oil sector exposes the group to volatility in the commodity market, especially since its fertiliser division is the largest contributor to topline. We believe the group is well aware of its dependence on the fertiliser business and has been diversifying its business to create a balance between its core business activities to mitigate the risks of an unfavourable cycle in certain business divisions. To provide a cushion against cyclical changes, the group has been growing its business in less cyclical segments such as the water treatment and pharmaceuticals sectors.
FINANCIAL HIGHLIGHTS
Strong topline growth. Over the past five years the Group’s topline has been grown at a strong CAGR of 22% owing to impressive growth in its fertilisers division, which has grown at a CAGR of 29%, compared to 17% and 14% growth in the chemicals and pharmaceuticals divisions respectively. The fertilisers division has generally been supported by strong demand from palm oil plantation sector due to the run-up in CPO prices. We believe the emergence of PNB as the group’s largest shareholders in 2005 had also driven fertiliser sales given PNB’s substantial shareholdings in oil palm plantations in Malaysia, which fuelled growth in the fertiliser division by almost 35% y-o-y in 2006. The continuous buoyant outlook in CPO prices And the higher selling prices due to shortage in global fertilisers supply have further pushed growth for this division by 35% y-o-y in 2007. Meanwhile, we believe the growth in the chemicals division is mainly attributed to higher demand from the industrial sector considering the stable demand for its watercare products. The acquisition of Duopharma in late 2005 resulted in the segmental contribution from pharmaceuticals doubling from RM100m in 2005 to more than RM200m in 2006.
EBITDA margins. Between 2002 and 2007, the Group’s EBITDA margins hovered at around 11.8% to 8.8%. Its pharmaceuticals division has always commanded the highest EBITDA margins compared with other divisions. Prior to the acquisition of Duopharma, the pharmaceutical division was drawing EBITDA margins of around 12.3% and post acquisition, this improved tremendously to around 30%, largely due to Duopharma’s strong position in the niche market segment, especially in the small injectables and haemodialysis solution segment that command higher margins. On the other hand, margins for fertilisers and chemicals division have been relatively bumpy due to volatility in selling prices and raw material prices. Over the past 5 years, margins for the chemicals division has been heading south due to tough competition from cheaper imported chemical products, which have prompted the Group to reshape its chemicals business to cater more towards niche markets. The margins of the fertilisers division have been volatile, reaching as low as 2% to as high as 12%. In 2006, EBITDA margins of the fertilisers division dipped to around 2% from 12% in 2005 due to stiff competition from lower quality NPK compound fertilisers and escalating raw material costs. At the Group level, the margins were rather stable in 2006 since the drop in margins of fertilisers division were offset by higher margins from the pharmaceuticals division.
Consistent earnings record. While revenue grew at a 5-year CAGR of 22%, PBT (excluding exceptional items) grew at more than 38%, which we believe was largely driven by better cost management over the years of expenses such as administration costs and other operating expenses. For instance, administration costs were around 8.3% of total revenue in 2001 and improved to around 4.7% of topline in 2007. We believe that improvements in cost management might have been driven by further consolidation and unification within its business divisions, especially its pharmaceutical division, as the Group had over the years been actively unifying its divisions in terms of securing raw materials, R&D and marketing activities, thus resulting in cost synergy within the Group.
VALUATION & RECOMMENDATION
Fertiliser division the star performer. We expect the fertiliser division to remain the group’s star performer in the next few years supported by a buoyant outlook for the agriculture sector, as well as capacity expansion at its manufacturing plants. Although its Bintulu plant is expected to commence production in mid-August 2008, we do not see a significant increase in production output given that it will be offset by the closing down of its Shah Alam plant for two months in 4Q08 for conversion work. We expect production capacity to increase by more than 50% supported by the full year contribution of the Bintulu plant and halfyear contribution from its Medan plant, which is expected to be fully operational in 1QFY09. We see more capacity expansion in 2010 with the commissioning of the Lahad Datu plant in 1QFY10 and expect the division to achieve production capacity of 670,000 tonnes by 2011, with an average utilisation rate of more than 80%. Going forward we anticipate margin improvements for the division, largely due to higher efficiency at its new Shah Alam plant once conversion work is completed, and the higher efficiency at its new plants, which will thus incur lower transportation and maintenance costs.
Acquisitions drive growth of chemical division. The outlook for the chemical division is expected to be stable but we expect moderate growth in 2008 and stronger growth in 2009, owing to the acquisitions of Enersave and Innovative Group in 2008. We expect Innovative Group to contribute less than RM15m to CCM’s topline in 2008, which is based on management guidance that the acquisition will be concluded in October 2008. However, we expect the acquisition of Enersave and Innovative Group to contribute more than RM130m to Group topline from 2009 onwards. Competition from cheap imports will remain the division’s key concern. However, we expect some margins improvement for this division, largely from Innovative Group which commands higher margins, and as the result of reshaping its business model from mass market products towards specialist chemical products.
Healthy growth in pharmaceuticals. We expect the pharmaceuticals division to register steady and moderate growth of around 12% for the next few years, which is in line with the Malaysian pharmaceutical industry’s forecast growth of 8% to12%. As the largest maker of OTC products in Malaysia, we believe the Group is in a favourable position to tap the industry’s growth potential, particularly for the OTC and generic drugs segment, supported by the upcoming expiry of several blockbuster drugs worldwide and growing health awareness. However, we expect some pressure on margins largely due to higher raw material prices such as packaging and active ingredients cost which have risen some 250% since early this year, and growing competition from cheaper imported generic products. We also expect higher cost of regulatory compliance in the pharmaceutical industry. Although the pharmaceutical division expects to contribute less than 15% to topline, we anticipate that the division will remain the biggest contributor the Group’s bottomline, largely due to its higher margins of more than 20% at PBT level. Although the pressure on material costs is expected to continue for the next few quarters, we expect further unification in this division, especially in terms of securing raw materials, R&D and marketing activities, to ease or partly alleviate some of the pressure on margins.
M&A potential. We do not rule out any possible acquisitions in the near future, particularly the acquisition of foreign pharmaceutical companies since the Group has indicated that it is actively looking for acquisition targets outside Malaysia, with special focus on Asean countries such as Indonesia, Vietnam, the Philippines, Thailand and also India as there are huge market potential there and CCM is willing to spend around US$40m-US$50m for acquisitions. Due to some restrictions on foreign ownership, CCM is looking for investment at the associate level with preference for a public listed company, where it is relatively easier for it to dispose of or exit the investment if it wished. Based on management guidance, we expect gross gearing to increase to around 0.7 driven by financing cost for the acquisition of Innovative Group and possible overseas acquisitions by the pharmaceutical division. There might be some concern over the funding of the acquisition since CCM’s gearing level is already quite high following the recent acquisition of Innovative Group. Management has indicated that it plans to ease its gearing by disposing of several noncore assets by the end of this year.
BUY. We see topline growing around 18% to 20% for 2008 and 2009. We foresee higher net profit growth of more than 17% y-o-y in 2009, thanks to the full year contribution from the acquisitions of Enersave and Innovative Group. We are initiating coverage on CCM with a BUY call and a target price of RM3.20 based on a DCF model and a discount rate of 8.3%, a risk-free rate of 4.5% and terminal growth rate of 2.0%. Our target price is equivalent to 16.7x PER on FY09 fully diluted EPS, which is also within the stock’s range of multiples of between 14x and 20x over the past two years.
A defensive long term investment. Although our target price offers limited upside of less than 15% on price appreciation, we believe CCM is heading towards the right direction in achieving sustainable growth momentum given its leading position in the fertiliser, pharmaceutical and chemical sectors and its export expansion strategy. Although there might be some concerns over its liquidity, we believe CCM is a good choice for long-term investors supported by the fact that its major shareholders are long term institutional investors such as PNB and EPF. The Group also has an attractive dividend payout guideline of 75% of PATAMI, which we believe is sustainable given that the Group has historically managed to pay dividends as guided.
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