ESG concern outweighs high CPO prices, RHB downgrades plantation sector to underweight

KUALA LUMPUR (July 30): Crude palm oil (CPO) price has climbed back to above RM4,000 recently; plantation stocks, however, are not moving up in tandem with the upward trend.

The reason is likely to be rising concern on environmental, social and governance (ESG) issues, according to RHB Investment Bank Research.

In view of that, its plantation analysts Hoe Lee Leng and Sean Chew have downgraded the regional plantation sector to “underweight” from “neutral” amid expectations that oil palm plantation companies would be devalued moving forward.

“We believe this devaluation of plantation stocks’ price to earnings (P/E) will likely be permanent, as more issues may crop up over time, and as investors become more ESG-aware and start pricing it into their investment decisions,” the two analysts wrote in a research note today.

They have cut their valuation targets and their ESG scores across the board, to reflect the anticipated devaluation.

“As more and more scrutiny is piled upon this sector, share prices and valuations will get dragged along with it,” they said.

Therefore, RHB Research lowered the valuation targets for all the stocks under their coverage, attributing an ESG discount to their valuation targets of 15% to 35%.

“We believe the sector should no longer trade at a premium to the market — particularly given the still relatively high foreign shareholding levels of some of the Malaysian planters under our coverage.

“Should foreign investors decide to exit the sector entirely, valuations could ‘derate’ further,” they said, adding that the research house has also lowered their ESG ratings accordingly.

For the big-cap planters in Malaysia, RHB Research has standardised its P/E targets at 20 times, from 25 times. For the mid- to small-cap Malaysian planters, they have now pegged P/E targets at 10 times to 13 times, from 12 times to 16 times.

Their top pick for Malaysian planters is Sarawak Oil Palms Bhd, as the stock is trading at an undemanding eight times of FY22 P/E, which is at the lower end of its small-cap peer range of between eight times and 13 times.

However, RHB Research reduced its target price (TP) to RM4.20 from RM4.65, given the prevailing ESG compliance issues and weaker CPO prices anticipated ahead.

The research outfit downgraded Genting Plantations Bhd to “sell” from “neutral”, and it has slashed its TP by 31% to RM5.90 from RM8.60.

Genting Plantations’ valuation is relatively expensive at 23 times of FY22 P/E, which is at the high end of its large-cap peer range of 18 times to 23 times, they said.

RHB Research also cut the TPs of IOI Corp Bhd to RM3.60 from RM4.05, and Sime Darby Plantation Bhd to RM3.90 from RM4.85.

Following the adjustment, Ta Ann Holdings Bhd was downgraded to “neutral” from “buy”, while its TP was cut by 20% to RM2.75, from RM3.45.

Meanwhile, they are maintaining their “neutral” calls on CB Industrial Product Holdings Bhd (TP: down to RM1.2 from RM1.40) and FGV Holdings Bhd (TP: RM1.30),

All said, the duo told clients that in the current export tax and levy scenario in Malaysia and Indonesia, pure upstream players in Malaysia and integrated Indonesian planters would stand to benefit more.

Unsustainable CPO price rally

Hoe and Chew do not think the current high CPO prices are sustainable. They believed that CPO prices have more downside than upside risk from hereon.

They said the current high prices will affect demand from price-sensitive countries, while reductions in biofuel mandates globally and rolling Covid-19 lockdowns will continue to have a dampening effect.

“We expect CPO prices to start declining in the fourth quarter of 2021, then remain in a downtrend in the first half of 2022,” they said. However, the rate of decline may not be as severe as initially expected, given the still weak productivity seen in Malaysia.

As such, they raised their CPO price assumptions for 2022 to RM3,000 per tonne (from RM2,800) and to RM2,900 per tonne for 2023 (from RM2,700).

They are maintaining their RM3,200 per tonne assumption for 2021, given the aggressive forward-selling policies that have been adopted by corporates, thereby resulting in lower realised prices.

“All in, we have raised forecasts by about 1% to 2% for 2021, while earnings estimates for 2022 to 2023 have been upped by 8% to 11%,” they said.

Hoe and Chew pointed out that the negative news flow on the ESG front is likely to hamper any price recovery for the sector, and things may get worse before they get better.

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