Nov 29, 2016 09:48:19

The Time is Ripe!

We may see pressure of weakening IDR due to rising uncertainty and Fed Fund Rate hike to positively affect CPO players’ earnings. This is further backed by slower wage hike in FY17 and supportive sector fundamental. We prefer LSIP for its cheap valuation and strong financial position.

CPO players as beneficiary of IDR depreciation… On higher chance of Fed Fund Rate hike in Dec and uncertainty of Trump policies, we may see market and pressure on IDR to persist. Given that the Indonesian CPO price is quoted in USD (CIF Rotterdam), we believe listed local CPO players’ earnings should benefit from IDR depreciation against USD. Based on our sensitivity analysis, for every 1% depreciation in IDR, both AALI's and LSIP's net profit would increase by 2.1% and 3.1% respectively. Benefit of IDR depreciation to AALI’s earnings is less profound as it was partially offset by higher forex arising from its outstanding USD-denominated loan.

… And slower wage hike. In addition, the Indonesian government has set minimum wage hike of 8.25% for FY17, which is a slower rate as compared to previous years’ increment of more than 10%. We think CPO players will benefit from slower wage hike as labor cost accounts for 20-30% of CPO players’ production cost.

Fundamental remains supportive of CPO price. We also think high CPO price within MYR2,800-3,000/ton should sustain in view of continued low inventory level for the next several months. The recently reported lower MoM Malaysia CPO output in Oct, we believe, may signal subdued production for the rest of FY16 and into 1Q17, the start of low crop season, hence capping further rise in CPO inventory level. Upcoming Chinese New Year demand and ongoing concerns on delayed soybean planting due heavy rainfall in Argentina and parts of Brazil continue to be a positive factor supporting CPO price.

AALI's and LSIP's performances lag behind the CPO price. Compared to the year-to-date 32% rise in CPO price, share prices of both AALI and LSIP underperformed by 22% and 4% respectively. We think share prices have been penalized as a result of deep production decline which negatively impacted earnings. On the other hand, AALI and LSIP are still reasonably valued at 14.9x and 14.2x FY17 P/E respectively (vs. peers' average of 14.3x). In summary, undemanding valuation coupled with better production and CPO price outlook ahead should present plenty of upsides for the stocks.

Who’s our preferred pick? Despite liking both AALI and LSIP for their stock price sensitivity to CPO price and good liquidity, we prefer to play LSIP to take advantage of
the CPO price momentum and potential weakening of the IDR. Aside from its cheaper valuation as compared to AALI, we like LSIP for its strong and debt-free balance sheet, which provides buffer to foreign exchange risk and rising interest rates. We currently have a buy recommendation on LSIP with TP of Rp1,950 based on 17.0x 3-year average rolling forward mean P/E. Our TP offers 19% upside from current share price.