Agri-Resources - Supportive 2Q09 Results

Stay OW: We maintain our PT for Indofood Agri-Resources’ (IFAR) at S$1.90 per share as we are keep our EPS estimates essentially unchanged. IFAR’s share price is now discounting a CPO (crude palm oil) price of US$770/T vs. our F2010 estimate of US$800/T, we estimate. At our PT, IFAR would trade at F2010 P/E of 11x, which we view as attractive against a sector average of 14x.

Supportive 2Q09 Results; EPS Unchanged. IFAR’s 2Q09 plantation profits grew 40% Q/Q, offsetting the lower profits from non-plantation divisions. The net impact is neutral to our estimates. Given positive company guidance, we expect better non-plantation profits in 2H09.

CPO Stocks Remain Tight: We believe the CPO price will remain firm in the near term. Indonesian FFB (fresh fruit bunch) yields recovered in 2Q09, but we continue to see tightness in global CPO stock levels in the near term for two reasons: 1) yield stress is not over in Malaysia as we see a yield recovery for Malaysia only in 2010; and 2) CPO export demand remains robust.

10% Upside: Our 2009-11 EPS estimates are 18% above consensus on our higher CPO price assumption. Long term, IFAR is one of top two picks within our CPO coverage; KL Kepong (KLKK.KL, OW, RM13.40) being the other. However, short term, we prefer Golden Agri-Resources (GAGR.SI, OW, S$0.48; +20% upside) and KLK (+19% upside) given their superior share price upside. Near-term catalysts: 1) Consensus earnings upgrade; 2) firm CPO price trend going into Ramadan festival; and 3) good 3Q09 results in November 2009.

Sponsored Links

Olam - A unique investment proposition

We believe Olam continues to be a good proxy for the agricultural theme, as the growth of long-term global demand outstrips supply. With a good farm-to-factory business model, sourcing and marketing presence in more than 60 countries, these trends will lead to volume growth and margin expansion opportunities.

Since 2007, Olam has pursued an integration strategy that involves selectively owning assets such as midstream processing capacity in the supply chain. This allows the Group to become less of a price-taker. While its traditional trading business nets a steady 2% margin, the market could have underestimated a potential expansion to 2.8% by FY11.

With a lowered gearing ratio of 1.8X following Temasek’s $437.5m equity injection in June, Olam now has sufficient credit headroom to pursue an estimated current pipeline of more than 10 M&A deals. In the post credit-crisis environment, we see more opportunities for acquiring good distressed assets at attractive prices, such the recent SK Food deal.

While Olam might seem highly leveraged using conventional ratios, such concerns are unwarranted due to the liquid nature of its large inventory. Furthermore, we believe the subsiding of the credit-crisis, Temasek’s equity injection, together with management’s recent voluntary reduction of target gearing level to 2.5X-3.5X, has sufficiently addressed this.

We believe Olam’s growth profile for a company of its size continues to present a unique proposition. We estimate Olam’s EPS (normalised) to grow at a CAGR of 27% from FY10-FY11, significantly above its peers. With this growth profile, we have pegged our target price of $3.05 to a premium 25X FY10F, which is still below its historical average of 31X PE.

Golden Agri-Resources Ltd: Maintain HOLD

2Q09 results mostly within expectations. Golden Agri Resources (GAR) released its 2Q09 results on Friday; revenue was down 30.7% YoY but rebounded 37.2% QoQ to US$565.6m, aided by slightly firmer QoQ CPO (crude palm oil) prices as well as higher production volume. The average CPO price fell from US$1117/ton in 2Q08 to US$696/ton in 2Q09 but was an improvement from US$511 in 1Q09. As a result, while net profit tumbled 64.7% YoY, it was up nearly 543.0% QoQ to US$55.1m. For the first half, revenue fell 37.5% to US$977.8m, meeting 41.9% of our original FY09 estimate, while net profit slid 78.1% to US$63.7m, or about 23.6% of our full year forecast.

CPO production likely bottomed in 1Q09. Operationally, it appears that the worst of the previous tree stress (due to the drought in 2006) has passed; CPO production increased 15.1% YoY and 30.8% QoQ, while CPO yield improved 1.5% YoY and 26.9% QoQ. We also understand that due to the better-than-expected production, GAR has about 100k ton of unsold CPO at end-Jun, but has since been sold. And while there may be a possible El Nino effect this year, management believes that the impact will probably be felt some 12 months later. It is also confident that it will escape the worst of the impact due to the dispersion of its oil palm plantations in Indonesia. Management is hopeful of seeing better production numbers in 2H09; also assured that it will not have excess unsold CPO this time around.

Bumping up our CPO assumptions. The recovery in the global economies has come slightly faster than expected and this has lent some support to crude oil prices and CPO prices. We have also raised our CPO assumptions for this year from US$600/ton to US$620/ton, and this in turn bumps up our FY09 revenue forecast by 6.8%. However, we raise our net profit estimate by a smaller 4.2% as GAR will still be working through the excess fertilizer that it had bought at a much higher price late last year; management expects to only enjoy lower fertilizer prices from next year onwards. We are raising our FY10 revenue and earnings estimates by 6.0% and 11.0%, respectively. Using a higher 12x blended FY09/FY10 EPS valuation (vs. 10x previously), our fair value will rise from S$0.35 to S$0.45. Given the limited upside, we maintain our HOLD rating.

Wilmar International – Price target raised to S$7.50 – maintain Buy

Wilmar posted 2Q09 results that were ahead of expectations, mainly from stronger commodity prices. Net profit came in at US$407.2m, up 22.7% from 2Q08, and up 7.1% sequentially. Wilmar has also continued its momentum from 1Q09, despite earlier indications that last year’s record earnings could not be matched. We now believe that the group is capable of surpassing this benchmark, and have raised our forecasts accordingly. Wilmar also declared an intereim dividend of S$0.03 per share.

Despite 2Q09 headline revenues declining by 27% YoY, sequential revenues have actually increased by 15% to US$5.7bn, on the back of a recovery in commodity prices. More encouragingly, however, sales volumes have increased across the board, with the minor exception of consumer products.

Despite this, the consumer division managed to hold on to its uncharacteristically high margins at 7.2%, versus 8.4% in 1Q09 and 1.6% in FY08. Merchandising & Processing saw some sequential erosion of margins, due to higher commodity input prices, but is still handily ahead of last year’s average. Its upstream Palm Plantation and Milling business naturally showed an increase in margins, from higher CPO prices.

We are raising our FY09 forecast by 21% to US$1,631m, and by 15% in FY10 and FY11. This implies a 3-year earnings CAGR of 10% versus our previous expectation of around 5%. Aside from the recovery in CPO prices, Wilmar will also be a beneficiary of an economic recovery in China and India, and has an established distribution network that it can use to grow its existing and new businesses.

With the earnings upgrade, we are raising our target price of Wilmar to S$7.50, from S$5.70 previously, and assigning a premium valuation of 20x FY09 earnings. Its application to list its China businesses in Hong Kong was recently approved, and we believe that Wilmar will be able to secure above-average valuations. We expect the listing to take place within the next two months, and strong investor interest in the stock is likely to continue, leading up to this.

AusGroup Ltd: Rio Tinto increases capex target for 2009 by 25%

Major AusGroup customer Rio Tinto released 1H09 results yesterday.

2009 capex target up 25%. Rio Tinto's management said they have revised their capex target upwards for 2009. The new target for 2009 capital expenditure is US$5b (up 25% from US$4b previously). US$2.7b of this amount is allocated for development projects.

Reviewing 2010 target. Management is also reviewing its 2010 target in light of improved market conditions. The previous target was for US$2.5b, allocated for sustaining capex only. It will release the new guidance in October.

Focus on "high definable near-term value".Rio Tinto said for the moment, it is focused on brownfield step-ups (increasing capacity, for instance). It said this was the most efficient allocation of capital (a small investment for a big uptick) in the current environment. Rio Tinto also said that down the road, "of course" it would invest in greenfields.

Confirms our view on AusGroup. This latest development supports our investment thesis that blue-chips in the minerals resources sector are "un-freezing" capital expenditure plans. We believe order wins over the next few months from both the mining and the oil & gas industries will underpin AusGroup's earnings performance in FY10 and FY11.

Maintain BUY with S$0.70 fair value (14x FY10F earnings or 10x FY11F earnings). Refer to our report dated 19 Aug 2009 for more details.

Indofood Agri Resources – Raising TP to S$2.10 – maintain BUY

IFAR reported 2Q09 results that were slightly ahead of our expectations. On a YoY basis, net profit fell 4.4% to Rp. 682.4b; stripping out its biological revaluation of Rp. 593.2bn, we estimate net earnings declined by 27%. On a sequential basis, however, core net profit rose 23%. Revenue declined by 30% to Rp. 2.3b, but was up 15% sequentially, in line with CPO price trends.

IFAR also recorded a Rp. 240bn forex gain on the back of the strength in the Rupiah, which mainly pertained to its US dollar denominated loans. For its core business, gross margins did see a decline to 33.5% versus 1Q09’s 41.2%. IFAR also saw sequential strength on CPO prices, which rose 24%. IFAR was also able to raise average selling prices by between 5-10% over 1Q.

Going forward, IFAR has raised its ASPs by a further 5% in July, and this is expected to hold steady for the next 2 months. More importantly, we expect sales volumes to increase through the second half of the year, in line with seasonal factors, as cooking oil consumption is expected to increaser through the festival seasons. IFAR’s cost of production is also expected to decline on lower fertiliser and fuel costs.

On a longer-term outlook, the fundamental demand for palm products remains strong, both in Indonesia and globally. IFAR’s leading position in the Indonesian branded cooking oil market makes it a prime beneficiary of this. We are adjusting our FY09 core net profit forecast upward by 7% to Rp. 1,144.5b, or an EPS of S$0.115. This is still 6% ahead of consensus estimate.

We are raising our target price to S$2.10 from S$1.35, based on a re-rating of palm related stocks to around 18x on the back of higher CPO prices. We also maintain our Buy recommendation.

SSH Corporation Ltd: Affected by further inventory provisions and low demand

Impacted by low demand, steel prices and provisions. SSH Corporation (SSH) reported a 13% YoY fall in FY09 revenue to S$217.6m and a 44% drop in net profit to S$15.5m as the group felt the impact of softer steel prices, lower demand and provision of inventories write down. Results were below expectations due to the inventory provision as well as lower revenue in the last quarter which made up 20% of our full year estimate. Excluding the write down of S$9.7m, gross profit margin would be about 26%, similar to that of FY08's. Although other income rose 98% YoY to S$6.4m due to increase in rental income, other operating expenses increased by 225% to S$3.9m due to an exchange loss of S$1.2m in FY09. We also note that gross gearing decreased from 0.48x as at 30 Jun 08 to 0.29x as at 30 Jun 09 as bank borrowings fell with lower working capital requirements.

Steel prices have likely bottomed out. As steel prices bottomed out in May this year and have recovered since, it is less likely that the group should require further provision for inventory write downs. Assuming adequate provision and if steel prices continue to recover, the group may book revaluation gains, but this will not be reflected in the income statement but rather in the revaluation reserve. Steel prices have trended upwards, supported by strong demand from certain countries such as China which have taken advantage of low prices to stock up on inventories. we see that China started experiencing a recovery in iron and carbon steel products imports from February this year, near the trough of the global composite steel price index. Although SSH mainly caters to customers in Singapore, Indonesia and nearby countries, there is the possibility that the group may expand its reach in the Chinese market since it can leverage on the network of KS Energy and Aqua-Terra Supply.

Maintain HOLD. Management expects that FY10 will remain "challenging and competitive" but pointed out that if the rise in oil prices is sustained, it may induce more oil exploration which increases the demand for SSH's products and services. We maintain our fair value estimate of S$0.16 as outlook remains murky with relatively low earnings visibility. As such, our HOLD rating remains.

Wilmar - China holds the key

Re-affirm BUY, with 16% upside to revised PT of S$7 We are increasing our margin assumptions for the plantation and processing businesses. We are also boosting our FY10F and FY11F earnings forecasts by 10% and 13%, respectively. We reiterate our BUY rating on the stock with a new price target of S$7, for upside of 16%. Our SOTP valuation on a segmental basis suggests a fair value of US$31bn for Wilmar.

Investors have started appreciating integrated Wilmar Palm & laurics and oilseeds processing account for 75-80% of Wilmar’s business. In our view, the market still does not fully appreciate Wilmar’s evolution into an integrated agribusiness player. However, since the China IPO announcement, the stock has started to decouple from physical commodity price movements, indicating that the listing and adequate information flow should correct this opinion.

China listing to drive valuation for the company At S$7, the implied value of the standalone China business as a geographical entity is US$14.5bn (19x FY10F earnings of US$763mn), which is undemanding versus other agri players in the region. This China valuation would imply that the rest of Wilmar’s business is currently trading at only 12.4x, which we consider attractive. We think a higher valuation of 25-30x for the China business could lead to a further re-rating of Wilmar shares. However, Wilmar would have to significantly raise its earnings growth profile to justify richer valuations.

Leader in China, but growth subject to regulations Wilmar derives ~50% of its business from China. Though it is the leader in the oilseed processing and consumer segments, regulatory risks could constrain future growth. In our view, investments in newer segments like rice/water will take time to begin contributing meaningfully.

Kencana Agri: Fast forward

2QFY09 earnings slightly weaker than anticipated. Kencana posted a 399.2% q-o-q jump in 2Q09 net profit to US$2.5m, mainly due to recovery in FFB (Fresh Fruit Bunch) yields. Annualized, this was nevertheless slightly lower than our projection as the recovery in yields was not as sharp as we had anticipated. The group expanded by 1,227 ha in 1H09 (1,886 ha YTD) faster than expected and is targeting to plant of 5,000 ha p.a. from 10F onwards.

New TP yields 24% upside. We reduced our expectations of the group's 09F and 10F FFB yield by 11.4% and 7.9%, respectively, as we believe our previous targets were aggressive relative to what they had achieved in 1H09. This resulted in 6.6% and 12.4% cuts in 09F and 10F earnings. However, faster-than-expected expansion this year and sustained target thereafter would result in a higher net profit from15F onwards. Using DCF (WACC 13.8%, terminal growth rate 3%), this raised our TP to S$0.40.

Going international. The group's recent JV with Louis Dreyfus Commodities (LDC) to build a deep-water port in Balikpapan (capable of accommodating large-size vessels) is expected to extend Kencana＊s markets and reduce costs. The group has bought (through the issuance of shares) US$2.0m worth of land for the JV. It is expected to be fully operational by end of 2010F.

Rating upgraded to Buy. We are encouraged by the group＊s expansion target, now that it is able to secure funding for its capex plans. We believe the group should sustain double-digit growth over at least the next five years.

Straits Asia Resources 2Q09 results highlights

1. Good operational results. Revenue exceeded our expectations at US$175.6m (+8.6% YoY, +25.7% QoQ). Gross profit came in at US$81.0m (+25.9% YoY, +22.4% QoQ). Gross profit margin grew by 6.4ppt to 46.1% thanks to higher selling prices and lower fuel costs.

2. Net profit tainted by non-cash charge.Earnings came in below expectations at US$21.4m (-43.3% YoY, -39.6% QoQ) due mainly to a US$14.3m non-cash charge from warrant expenses. Excluding this, net profit would have met our estimates at US$35.8m (-5.4% YoY, +0.8% QoQ).

3. Outlook positive. The group is on track to deliver record earnings in FY09. It is confident of meeting its 9mt production target. Management remains positive on its outlook, citing recovering energy demand.

4. Good dividends, undemanding valuations.SAR has declared an interim dividend of 1.14 US cents, in line with its 60% payout policy. SAR trades at an undemanding 9.8x FY09F PER coupled with a relatively good 4.1% dividend yield.

5. Risks. Key risks to note are a deterioration of global energy markets and refinancing risk. SAR faces a repayment schedule of US$94m in 2009 and US$125m in 2010. It is in the midst of negotiations to refinance the loan.

El Nino is back; plantation stocks may outperform

This month, the Australian Bureau of Meteorology and the US NOAA declared that El Nino has returned and may last for the rest of 2009. El Nino is a hot weather phenomenon which tends to be negative for agriculture production, but good for prices. Already, we have seen signs of adverse weather - the Indian monsoon has been weaker than expected (delaying plantings of oilseeds and other crops) while rainfall in Indonesia and Malaysia has been below normal since May.

El Nino is typically negative for CPO (crude palm oil) production, but prices tend to rise sharply and overall it tends to be a net positive for plantation companies. For example, after the 1997-98 El Nino CPO production declined 2.7% YoY, but prices increased by 21%. Even if CPO production is not severely affected, there can also be indirect impacts on competingcrops – e.g. during the 2002/2003 El Nino, India experienced a severe drought and domestic oilseed crops failed, boosting CPO imports.

Typically, the negative impact on CPO production from drought only manifests 10-12 months later (although the impact on competing crops like soybeans is more immediate), but share prices and CPO prices react more quickly. For example, in 5 of the last 7 El Nino’s, plantation stocks out-performed the market by 5% - 93% during the event.

Even if El Nino has no significant impact on agriculture production, we remain bullish on CPO price fundamentals due to 1) Slowing CPO production growth (from yield stress and Malaysia’s replanting incentive); 2) Tight soybean supply; 3) Robust, inelastic global edible oil demand and 4) Increasing government mandates for bio-diesel, 5) Rising oil prices. Wilmar (Buy, Conviction List) remains our top pick in the sector, but we note that IFAR (Buy) has the highest earnings leverage to CPO (a 10% increase in CPO boosts 2010E EPS by 21%).

Noble - Riding the wave of recovery

Ripe for recovery. Global economic trends have improved in recent months and so has the outlook for Noble Group Ltd (Noble). The worst of the recession appears to be behind us with 2Q09 GDP figures showing QoQ improvements across several countries. These trends are in line with the International Monetary Fund's (IMF) projections, which predicted a bottoming out of global economies by 2H09 (exhibit 1). Credit markets have also started to thaw, helping to boost global trade flows. Noble, being a global commodities supply chain manager, will be a key beneficiary of the economic recovery.

Metals and Energy could spring positive surprises. Noble's Metals and Energy divisions could surprise on the upside given the resurgence of demand and prices in 2Q09 (exhibit 2). Metals and energy typically displayhigh sensitivity to real economic conditions, and we expect these segments to lead the economic recovery. Flow through effects of pump-priming initiatives, coupled with inventory re-stocking, has supported global activity in recent months. Going forward, robust demand from emerging economies such as China should continue to fuel demand for commodities.

Gloucester acquisition: a strategic move with earnings accretion. We have raised our FY09 and FY10 estimates marginally to reflect earnings accretion from Gloucester Coal. Noble has successfully gained control of Australia-listed Gloucester Coal with a 87.7% stake. This acquisition notonly boosts the group's earnings, but more importantly, secures Noble's strategic long term access to coal supplies. The acquisition is in line with Noble's strategy of increasing its assets, forms a good fit with the group's existing product portfolio, and should be easily digestible as we estimate that the acquisition cost formed no more than 2.5% of Noble's 1Q09 cash holdings.

Improving outlook; upgrade to BUY. Noble has consistently maintained a healthy financial position and managed to grow its volumes despite challenging operating conditions in 1Q09. The group will be announcing its 2Q09 results on 13 Aug 09, during which we will be paying attention to its segmental tonnage performance and balance sheet health. We rollover our valuations to blended FY09/10 earnings and raise our peg to 13x (from 10x), similar to levels seen in the 2003 recovery, bringing our fair value estimate to S$2.26 (previously S$1.62). We upgrade Noble to BUY on improved economic outlook. While we remain mindful of the risk of a double dip in commodities demand, the expected economic recovery in 2010 provides support for Noble's medium term performance.