Plantation stocks have been buffeted by the precipitous fall in crude palm oil (CPO) prices in recent weeks. The steepness of the price drop, over such a short period of time, has caught many by surprise.
It is uncertain if prices have hit a bottom but the momentum certainly appears downward biased, at least for the moment. Hence, sentiment for the sector as a whole is likely to remain weak.
Fall triggered by oil price correction
After holding fairly steady at around RM3,500 per tonne for the better part of this year, CPO prices tumbled below RM2,400 per tonne last week. Benchmark futures contracts traded on the Bursa Derivatives are currently hovering just above RM2,400 per tonne, down by some 30% in little over a month.
The finger of blame was pointed squarely at the drop in crude oil prices, which have fallen from a record high of US$147 (RM492.45) per barrel to about US$115 per barrel currently.
Cheaper crude oil translates into less financial incentive to produce alternative biofuel. This would, in turn, crimp demand for corn and other oilseeds, including CPO, that are used as feedstock to produce ethanol and biodiesel.
There were also some concerns that mandatory biofuel quotas in the US and Europe could be suspended or delayed. Usage of food crops to produce biofuel has been blamed for rising prices of food worldwide.
The recent strengthening in the US dollar has further accelerated the fall in commodity prices including crude and edible oils ? most of which are denominated and traded in the greenback.
CPO production outpaces demand growth
On the supply side, global crop production outlook has also improved significantly with more favourable weather conditions.
This is a sharp reversal from when devastating US Midwest flooding in June was feared to have destroyed corn and soybean crops, the main competitors for CPO both as food and biofuel feedstock.
Currently, US corn crop is on track for the second largest harvest ever. The projected recovery in stockpiles exerted additional downward pressure on prices.
Malaysia's production of CPO has been rising at a faster pace than demand, so far this year. CPO output up to July increased by about 21% year-on-year to 9.76 million tonnes.
Exports, on the other hand, have grown by a lesser 16% y-y to 8.33 million tonnes during the same period. As a result, stockpiles have grown ? to as high as two million tonnes in June before being pared back slightly to 1.98 million tonnes in July on the back of higher exports.
Impact on TSH slightly more muted
Lower CPO prices will affect earnings of plantation companies. Positively, the impact on TSH Resources (RM2.05) is likely to be slightly more tempered.
TSH has locked in about one-third of projected CPO sales at about RM3,400 up to March 2009. This will buffer the company somewhat in the current sharp price correction. We lowered our average selling prices from RM3,200 to RM3,100 per tonne in 2008.
High double-digit growth in fresh fruit bunches (FFB) processed will also lend some support to earnings going forward. We estimate total throughput increased by over 20% y-y in 1H08.
The company has a very young oil palm age profile. Currently, most of the FFB processed are acquired from outside parties. We expect output from its own plantations to increase at a rapid clip in the coming years.
Refinery diversifies earnings risks
The company's investment in a downstream refinery, a joint venture with Wilmar International, also helps diversify some earnings risks. The associate company is doing well and is estimated to contribute roughly 25% of TSH's pre-tax profit this year.
TSH's cocoa processing business also generates fairly steady earnings and cash flow. The business is mature with little capital expenditure required. Cocoa processing accounted for about 16% of operating earnings (excluding unallocated expenses) in 1H08.
Net profit stood at RM60.3 million in 1H08. We estimate earnings for the full year at roughly RM117 million or 28.3 sen per share, before declining to RM111.9 million in 2009 on the back of lower selling prices.
Having tumbled to their lowest level for the year, in line with the selloff in plantation stocks, TSH shares are currently trading at relatively modest P/Es of 7.2 and 7.6 times our estimated 2008-2009 earnings.
Note: This report is brought to you by Asia Analytica Sdn Bhd, a licensed investment adviser. Please exercise your own judgment or seek professional advice for your specific investment needs. We are not responsible for your investment decisions. Our shareholders, directors and employees may have positions in any of the stocks mentioned.
Published by The Edge Communications Sdn Bhd
