Noble Group Ltd: Our preferred pick within the commodities sector

Rosy prospects at undemanding valuations. Evidence of a global economic recovery has enhanced investors' preference for cyclical stocks such as commodities. Most stocks have appreciated significantly on expectations of earnings recovery, leaving few with cheap valuations. Against this backdrop of weighing the twin objectives of valuations and outlook, we reiterate Noble Group Ltd (Noble) as our preferred pick within the commodities sector. Noble has performed exceedingly well against an extremely challenging boom-and-bust cycle in 2008 and 1H09. Relentless market share gains have driven volume growth and good balance sheet management has yielded the group superior financial flexibility to capitalise on inorganic growth opportunities. We expect Noble to reap the rewards of its good management in FY10 as global economies recover and commodities markets normalise.

Multiple growth drivers, strong financial flexibility. Noble's growth prospects are backed by several drivers: (i) market share gains as buyers seek quality counterparties, (ii) normalising commodities markets, (iii) new capacity coming on stream, and (iv) inorganic growth. Noble recently acquired distressed assets of SemFuel via bankruptcy proceedings. The acquisition is expected to boost its product portfolio and enhance synergy. We believe that more distressed assets could emerge from the economic slump. Noble is well positioned to capitalise on such opportunities given its strong cash position (US$805.8m as of 1H09). The group's prudent balance sheet management has allowed it to fund acquisitions without needing to raise additional capital. In contrast, its peer Olam has recently raised additional capital to fund inorganic expansion, at the expense of diluting existing shareholders' interests.

Reiterate BUY, fair value raised to S$2.50. We have raised our FY10 revenue and earnings assumptions on the back of stabilising commodities prices. This lifts our fair value estimate to S$2.50 (previously S$2.26). Despite the recent share price appreciation, Noble trades at just 13.6x FY09F PER, a sharp discount to Olam's 22.7x PER. Current valuations are also undemanding against its historical valuations of 4.1x to 22.1x PER. The stock may see an upward re-rating as investors gain appreciation of its sound balance sheet health. We maintain our BUY rating on the stock.

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Wilmar International: Stronger then expected 2Q09

Ahead of expectations. Wilmar's 2Q09 EBIT and net profit rose by 8.8% and 14.0% y-o-y to US$538.7m and US$378.1m, respectively - despite a 27% y-o-y drop in revenues to US$5,712.3m. The group's 2Q09 pretax margin eased to 9.2% from 10.5% in 1Q09, but rebounded from 5.6% in 2Q08. Sequentially, palm & lauric merchandising and processing (M&P) pretax margin/MT declined to US$41 (from US$55 in 1Q09); although that for oilseeds dropped to US$27 (from US$47 in 1Q09). While flat to weaker oilseeds M&P margin was anticipated, that for palm & lauric came out stronger than expected. The group's consumer products also posted strong pretax margin of US$88/MT (vis-vis our initial forecast of US$35/MT for the full year).

Recovering commodity prices reflected in higher debts. Short-term borrowings increased to US$6.1b from US$3.4b in 1Q08 mainly to account for higher working capital needs on recovering feedstock prices q-o-q. Total borrowings increased to US$7.7b at the end of June translating to net gearing ratio of 37.8%, up from 22.6% in 1Q09.

TP upgraded to S$7.25, Buy call reiterated. We raised our assumption of palm & lauric M&P margin to 5.8% (from 4.4%); but reduced that for oilseeds M&P to 7.0% (from 7.7%). We also raised consumer products' margin assumption to 7.0% (US$87/MT) from 2.8% (US$35/MT), in light of the stronger-than expected performance. FY09F-10F earnings were hence upgraded by 13.2%-12.5%. We raised our DCF-derived, fully diluted fair value to S$7.25 (WACC 9.8%, terminal growth rate 3%). Our Buy call is reiterated for 16% upside (excluding 1% FY09F dividend yield).

Indofood Agri Resources - 2Q09: Results above expectations; expect sturdy margin in 2H09

2Q09 core net profit jumped 78% qoq due to higher CPO ASP. We expect margin to remain stable in 2H09. We raise our target price to S$2.00 on higher margin assumption and a stronger rupiah against the US dollar.

Strong 2Q09 earnings on higher ASPs and forex gains. Indofood Agri Resources (IFAR) posted strong 2Q09 core net profit (excluding changes in fair value of biological assets), which increased 78% qoq to Rp427b. This was mainly attributable to higher crude palm oil (CPO) average selling prices (ASP) (+24% qoq) offset by lower CPO sales volume (-3% qoq), as well as forex gains of Rp240.2b in 2Q09 vs a loss of Rp94.8b in 1Q09.

1H09 core net profit, however, declined 21% yoy. Results are above our expectation as 1H09 core net profit represents 63% of our previous forecast. EBITDA margin improvement in 2Q09. EBITDA increased 31% qoq in 2Q09 on stronger revenue while cost held steady. Therefore, EBITDA margin improved to 37% in 2Q09 from 33% in 1Q09.

Sturdy CPO production ahead. As about 40% of plantation area is in the prime age and can produce high yield, and another 29% is expected to become mature area of about 54,789ha, we expect fresh fruit bunch (FFB) production to increase at a three-year CAGR of 9% in 2008-11.

Expect stronger revenue and sustainable margins in 2H09. We expect IFAR to post robust revenue growth in 2H09 on the back of sturdy CPO prices and higher production volume. Moreover, we believe margins in the plantation division are sustainable thanks to lower fertiliser purchase prices. Fertiliser prices ytd have fallen 30% compared with that in 2008. And IFAR’s current fertiliser price is 10% lower than in 1Q09.

Maintain BUY. As we have lifted our earning forecasts, we therefore raise our target price from S$1.45 to S$2.00, based on 12x 2010F PE for mid-cap and integrated plantation players.

More clarity on Wilmar China IPO valuation?

Strategic investment by the Kuok Group: In an announcement yesterday evening by Wilmar International (WIL), Wilmar China Limited (WCL) – a wholly-owned subsidiary and the entity for the China business IPO – has sold 1.61% of the enlarged issued share capital of WCL for HK$1.93 billion (US$250 million) to 3 entities (Kerry Holdings Limited, Great Cheer Limited and Zheng Ge Ru Foundation) which are members of the Kuok Group. This essentially values WCL at ~US$15.5 billion based on our estimates.

Valuations: The transaction price values WCL at 20x/18x & 19x/17x consensus/J.P. Morgan earnings estimates for FY09E/FY10E based on 50% of WIL’s group earnings (which is derived from China).

Subscribers to top up in the event of better valuation achieved: The announcement further indicated that in the event the valuation obtained in the IPO is higher, the subscribers will be required to top up the valuation difference to WCL while no adjustments will be made if the valuation achieved were equal or lower.

Transaction sets a floor valuation, confirming management guidance: We believe this transaction essentially sets a floor to the valuation of the China business IPO at ~20x P/E which sends a strong signal that the 20-25x P/E valuation range guided by the company is achievable.

First Resources - Remain cautious due to earnings volatility

Despite strong 2Q09 results and the strengthening of the rupiah against the US dollar, we remain cautious on FR’s earnings volatility on cross currency swap. Downgrade to SELL with a fair price of S$0.90.

Focusing and expanding on upstream business. FR plans to expand its upstream business through expanding its plantation business with long-term target of about 200,000ha. Currently, FR owns about 170,000ha of landbank and planted area of 100,300ha (nucleus and plasma). It will only expand its downstream business once its crude palm oil (CPO) production hits 1.0m tonnes. In 2008, it produced about 323,000 tonnes of CPO.

Higher CPO production coming on stream in 2H09. On the back of the usual seasonality patterns in 1H09, FR expects 2H09 CPO production to exceed 1H09 by about 18%. It targets a 10% yoy increase in CPO production in 2009 and another 10% yoy growth in 2010.

Most CPO production would be sold on “spot-basis” in 2H09. FR has a selling policy to maintain forward selling by not more than 40% of total CPO production. In 2H09, FR expects most of its CPO production to be sold on “spot-basis”. It sells only about 15% of its production based on forward contract. Its long-term contract with Wilmar is expected to expire by the end of 2009.

We raise our net profit forecasts for 2009 and 2010 by 4% and 3% to Rp619b and Rp886b respectively after fine tuning our models given a stronger rupiah vs the US dollar.

Downgrade to SELL with a higher fair price. As we rollover our PE valuation into 2010F, we raise our fair price from S$0.39 to S$0.90, pegged at 10x 2010F PE (small-cap, upstream player). However, as the share price of FR has exceeded our fair price and we remain cautious on its earnings volatility, we downgrade the stock to SELL. We prefer Indofood Agri Resources (BUY/Target: S$2.00) on better earnings visibility and undemanding valuation of 11.4x 2010F PE.

Wilmar - Need To Expedite

A Department director of China’s National Development & Reform Commission yesterday warned that the soy crushing capacity in the country is “far larger than needed”, suggesting Beijing could push for consolidation in the sector.

(About half of the 80 mln tones of annual soy crushing capacity were not operating in 2008, vs 44% utilization in 2007. The situation is unlikely to improve in 2009, hence the need for consolidation.)

Wilmar is the largest in China with daily average capacity of 32,000 tonnes, vs state-owned COFCO’s 17,100 tonnes. As China had earlier restricted expansion by Wilmar, the latest news should not affect it that much.

Even so, it should expedite the listing of its China operations in Hong Kong. (It has been 4 months since Wilmar first confirmed such plans.) Indications are that the IPO by end ’09 is on track.

We have a Trading BUY on Wilmar, pending the HK listing, and despite its “rich” valuation. At $6.50 (market cap of S$41.19 bln), Wilmar is on 17.5x latest 12 months earnings of US$1643.34 mln / S$2347.62 mln.

Golden Agri-Resources - 2Q09: Strong results but below expectation

Net profit of Golden Agri Resources (GGR) soared by 543% qoq in 2Q09. As share price has exceeded our fair price, we downgrade to stock from BUY to SELL.

Strong results in 2Q09, but still below expectation. Net profit of Golden Agri-Resources (GGR) soared by 543% qoq to US$55m in 2Q09 on the back of higher palm products production (+30% qoq) and higher CPO price.

However, 1H09 net profit still declined 78% yoy due to lower ASP, higher fertiliser costs and lower production. Results were below our expectation as 1H09 net profit represents only 25% of our full-year forecast.

CPO production volume recovered in 2Q09. CPO production rose 31% qoq in 2Q09 but still fell 2% yoy in 1H09 as the company experienced poor 1Q09 production on the back of biological tree stress, and less favourable weather conditions, mostly in southern parts of Sumatra and South Kalimantan.

Margin improved on sturdy CPO prices. Gross margin improved to 23% in 2Q09 on stronger CPO prices. But 1H09 gross margin declined to 20% due to forward buying on higher fertiliser cost as well as lower selling prices.


Target 30,000ha of new planting in 2009. GGR targets new planting area of 30,000ha for 2009. During 1H09, the company added 9,800ha of new planting area. This year, the company has a capex of about US$225m.

Higher earnings in 2H09. We expect higher earnings in 2H09 than in 1H09 on the back of sturdy CPO prices in 2H09 as well as improved margins mainly from lower fertiliser cost in 2H09. Management indicated that nucleus production cost (ex-mill) is expected to maintain at US$250/tonne in 2009.

Downgrade to SELL. As share price has exceeded our fair price, we downgrade GGR from BUY to SELL with a fair price of S$0.48, based on 12x 2010F PE for mid-cap and integrated plantations players. We recommend investors to take profit on GGR and start to accumulate at S$0.40.

Straits Asia - Forestry request approved

Straits Asia has been granted permission to mine the Northern area of its Sebuku operations, the so-called Cagar Alam concession, after waiting for over three years. The approval is inline with our long-time expectation and incorporated in our current valuation and price target.

The advantages of the approval are four fold for Straits Asia; that is, 1) 50-60mt higher reserves from a 12 meter thick coal seam, 2) 2-6mt higher production in the medium-term, 3) lower weighted average costs due to low 4x stripping ratio, and 4) weighted average higher selling price due to higher coal quality. We expect the company to increase production within nine months and for the Sebuku mine to produce 3-4mt in 2010.

We re-iterate our Buy rating on Straits Asia despite its strong performance year-todate as we expect a shortfall in thermal coal over the next two years. We believe coal demand will regain momentum inline with economic growth, while supply remains tight due to neglect and lack of investment. As Chinese metal smelters ramp up production in H209, we note that coal prices should strengthen further as they account for 25-30 pct of power consumption.

Our 12-month price target of S$2.50 is based on a 2010E PE multiple of 12.7x and WACC of 13%.

Olam - Growth is in the price

Olam is trading at 23x diluted FY10F EPS, a significant premium toother regional agri players. We believe the stock is fully pricing in our diluted earnings CAGR of 18% over FY09F-FY11F, and implied upside is limited. We thus downgrade Olam to NEUTRAL from Buy.

We increase FY10F earnings by 6% and by 2.5% for FY11F, driven mostly by lower assumptions for debt and financing costs as compared to our earlier estimates.

Delivering returns on investments and M&A’s will be critical in determining the company’s future business momentum. Olam has invested about US$750mn in various mergers and acquisitions over the past two years. We believe it has seen mixed results in integrating and improving the profitability of new ventures.

Recent equity dilution worth S$437mn to Temasek helps Olam’s balance sheet. Olam’s net gearing should fall from ~4x in FY08 to 2.1x in FY10 post dilution. The near-term impact from the stake sale looks positive, as our calculations indicate FY10F earnings would have been 5% lower sans equity raising.

We recommend switching from Olam to Noble Group as we expect Noble to outperform Olam driven by attractive valuations on a similar return profile, key Greenfield investments nearing maturity and likely re-rating due to restructuring of its coal assets portfolio.

Indofood - Misperception and earnings growth – strong stock drivers

The misperception of Indofood’s earnings quality and growth suggests significant upside. Importantly, the noodle business, and not CPO, will drive future profits, accounting for two-thirds of NPAT. We raise our earnings estimates by 27% and 32% for FY09 and FY10, respectively, putting us at 36% ahead of the Street.

We believe there is material upside to our estimates as they are based on a modest 2% increase in noodle prices, a wheat price that is 15% higher than spot and an assumption of no debt paid down.

We believe that Indofood’s earnings are relatively insulated from the volatility in commodity prices. Indofood is 3x less volatile than pure CPO plays. A 10% increase in wheat prices can be offset by a < 2% increase in the price of noodles.

As Indofood is trading at 10.6X FY10 (7.1X ex-IFAR), we find it attractive. We raise our target price to Rp3,500, implying FY10 P/E of 14.7X and 11.7X ex-IFAR, a material discount to regional peers’ 15.2X. The implied valuation does not appear to be too demanding given the stability of the company’s earnings, and because it is one of the best proxies to domestic consumption. Risks: rupiah volatility and rising wheat prices.

First Resources: New US$100m CB to have 7% dilution

First Resources today announced the issuance of US$100m new Convertible Bonds (CB) with 5.625% coupon and conversion price of S$1.24735/share using fixed exchange rate of S$1.4479/USD. The tenor for the CB is 5 years (maturity date 22 September 2014) at 104.34%; with a put option in 3 years' time (22 September 2012) at 102.44% (yield to put: 6.375%).

As a result of the issuance, the group's net gearing is estimated to decline slightly to 0.23x from 0.26x as at 30 June 2009 after accounting for the value of the equity portion of the CB, minus cash received (net of issuance cost).

Upon full conversion, the CB would represent 116,078,086 new shares, or 7.3% potential dilution - to the current share price (excluding net interest) or to S$1.02 in our TP (from S$1.10). We will account for the dilution when it is in the money.

We are maintaining our Hold call on the stock with TP S$1.10.

Olam - Sell-down overdone

Olam announced the launch of a new 7-year convertible bond issue of US$400m. While the market should not be surprised at new debt-raising, given management’s earlier explicit intention to gear up, we believe a potential equity dilution of about 10% will result in slightly negative sentiments.

Management expressed that the main attraction of this deal was the long tenure, which is in line with its intention to lengthen the overall term of its debt portfolio to match higher asset intensity. While the entire amount may not be utilised in the immediate term, being backed by this cash will give management the confidence in executing M&A plans.

Post-CB, Olam has an estimated cash position of US$900m. With no immediate re-financing needs, non-utilised cash for the moment will be used to retire existing higher interest debt. CEO Sunny Verghese stated that there is unlikely to be another equity-linked capital raising exercise for the next 3 years and reiterated the target gearing ratio of 2.5-3.5X for working capital and 1-2X for long-term assets.

Separately, Olam also announced the acquisition of a stake in New Zealand Farming Systems Uruguay (NZFSU), a New Zealand-listed firm with its dairy farming operations in Uruguay. The stake was purchased via Hunter Hall Investment Management. At this moment we believe earnings contribution is negligible, although this small non-controlling stake could be a precursor to a larger stake in the future.

While we believe there could be a potential share price overhang around the conversion price, the 7.3% sell-down has been overdone, and is a good entry point for investors. Conversion price now represents a 35% premium to current share price. We maintain our target price of $2.98 which is based on 25X 2010F.

Indofood Agri Resources - Outsized good results

Indofood Agri Resources (IndoAgri) reported 2Q FY09 results before the market opened on 14 August. Net profits declined 3.9% YoY, down 19.3% YoY if one excludes the effect of a non-cash bio-asset revaluation gain.
The lower YoY revenues were primarily due to lower prices, which were partly offset by higher volumes produced.

After taking into consideration two distorting items (ie, bio-asset revaluation and forex gains for a US dollar-denominated balance sheet/revenue cross-hedge), the results were slightly better than our expectation. As a result, we have raised our FY09 adjusted net-profit forecast (excluding bio-asset revaluation) by 9.6%. Our new adjusted net-profit forecasts are now in line with Bloomberg consensus. Including the bio-asset revaluation, we have raised our FY09 net profit forecast by 50.9%. No major surprises were announced at the company’s analyst briefing.

Our six-month quantitative-model-derived target price is S$1.08. The downside reflects our assumption that IndoAgri’s stock price will follow the crude palm oil (CPO) price lower to our projected target level of US$525/tonne by 31 December 2009 from its current level of around US$700/tonne.

We have a Sell rating on IndoAgri, based on our view that CPO prices may decline by year-end. This anti-consensus view is based on our thesis that global CPO supply will rise HoH in 2H09 due a recovery from impaired yields from ‘tree stress’ and the seasonal peak growing season.

Noble Group Ltd: 2Q09 in line, outlook improving

2Q09 results within expectations. Noble Group Ltd's (Noble) 2Q09 performance was in line with expectations. Revenue eased 31.2% YoY to US$7.2b along with lower commodities prices, while net profit doubled to US$248.8m thanks to a one-off revaluation gain arising from the Gloucester acquisition. Stripping away this gain, net profit would have contracted by 22.6% to US$94.8m. Sequentially, Noble's performance improved with revenue gaining 18.0% and net profit expanding by 5.1%. The operating environment displayed signs of normalising in 2Q09, leading management to adopt a more confident stance as it heads into 2H09.

Growth in market share. 1H09 tonnage grew 19.4% YoY, demonstrating Noble's ability to grow its market share despite harsh operating conditions. With the exception of Agriculture, all other segments reported higher tonnage. The group's market share gains put it in good stead to leverage on the economic recovery when demand for commodities strengthens. In particular, we expect tightening energy markets to drive Noble's growth in 2H09. Higher energy prices have already helped to buoy the energy segment's gross profit margin, which expanded to 2.3% in 2Q09 from just 0.9% in 1Q09.

Blip in MMO does not taint outlook. A blemish in its 2Q09 results came from the Ferro Alloys division's losses - the result of a collapse in prices. This resulted in gross profit margin contraction for the Metals, Minerals & Ores (MMO) segment. Nevertheless, management remains confident of the MMO segment's outlook, citing strong performance from all other divisions coupled with robust tonnage growth. Normalising economic conditions and sustained demand from China will support its performance going forward.

Balance sheet remains healthy. Noble's conservative balance sheet management has enabled it to tide through volatile commodity markets, and will equip it with financial flexibility to emerge stronger from the downturn. Inventory hedge ratio remained healthy at 94%, a slight improvement over the 93% recorded in 1Q09. The group's inventory levels rose from US$1.8b to US$2.0b, and according to management, this is a precursor of improving conditions ahead. Adjusted net gearing came in at a conservative 0.15x (vs. a net cash position in 1Q09), and credit facilities remain ample at US$3.4b.

Improving outlook; maintain BUY. We expect Noble to be a key beneficiary of the global economic recovery. Improving demand and supply fundamentals, the resurgence of commodity prices and market share expansion will drive its 2H09 performance. Valuations remain undemanding at 12.2x FY09 PER (vs peer Olam's 27.3x). We maintain our BUY rating and S$2.26 fair value estimate.

Golden Agri-Resources - 2Q09 Yields Surprise

Reiterate OW: We upgrade our PT to S$0.55 per share on higher FY2009-11e EPS estimates. The share price for Golden Agri-Resources (GGR) is now discounting a CPO (crude palm oil) price of US$730/T vs. our FY2010 estimate of US$800/T. GGR will trade at FY2010e PE of 10x at our new TP, low against sector average of 14x.

Surprise in 2Q09 Yields… GGR’s 2Q09 FFB yields came in 22% higher than our estimate and 4% above 2Q08. Indonesian-wide FFB yields, which suffered from tree stress since 2H08, is now back to normal, we think. …Drive EPS Upgrade. 2Q09 net profit came in 54% above our estimates on positive operating leverage unleashed from the higher-than-expected CPO production/sales volume. We revise our EPS estimates higher to account for the higher CPO production/sales volume and margins.

CPO Stocks Remain Tight: Despite the recovery in Indonesian production yields in 2Q09, global CPO stocks remain tight in the near term for two reasons: 1) Yield stress is not over in Malaysia. We see yield recovery only in 2010 for Malaysia; and 2) CPO export demand remains robust.

Best Upside within Coverage: Our 2009-11e EPS estimates are 27% above consensus, mainly on our higher CPO price assumption. Currently, GGR has the best share price upside of 20% within our coverage universe. Near-term catalysts: 1) Consensus earnings upgrade; 2) Firm CPO price trend going into Ramadan festival; and 3) Good 3Q09 results in November 2009.