M&A interest strong despite weak CPO price cycle, says Maybank analyst

Opportunities lie within the small-and-mid cap space given the huge valuation gap between estate values and stock prices, which may lead to potential M&A or privatisation


Plantation sector stocks are expected to see some volatility until the crude palm oil (CPO) price recovers from the second quarter of this year (2Q19) onwards, Maybank Investment Bank Bhd (Maybank IB) said.

Its analyst Ong Chee Ting said investors should be mindful the sector is likely to report a set of weak 4Q18 results in February 2019.

“This is because CPO spot price has been weak, averaging just RM1,920 per tonne in 4Q18 versus RM2,189 in 3Q18 and RM2,606 in 4Q17.

“RM1,920 is below the cost of production (per CPO tonne) for a lot of planters,” Ong noted in a recent sectoral report.

The analyst said a meaningful CPO price recovery could set in likely in 2Q19 after the current cycle of price weakness ends.

There has been two occasions in the last two decades when CPO price had traded at or below the industry’s cost of production (per CPO tonne) — in 2000-2001 and 2008-2009 — and the scenario repeated in the second half of 2018.

History shows low CPO spot prices usually last for about six months before price recovery sets in as producers cannot afford to continuously sell below cost over an extended period of time.

Ong believes the edible oil is already into the fourth month of low spot prices and this could potentially extend for another one to two months.

Time to Focus on Small-and-mid Cap Stocks

While valuation of the large-cap sector stocks has been relatively resilient despite the recent CPO price downturn, Ong reckons opportunities lie within the small- and mid-cap space given the huge valuation gap between estate values and stock prices, which may lead to potential mergers and acquisitions (M&A) or privatisation.

“We are not suggesting any impending M&A or privatisation offers, but prolonged low equity prices will likely tempt major shareholders or corporate raiders to seek out good deals.

“Even without those, this is still an opportune time for long funds to accumulate on bombed-out small-cap stocks (especially those trading near or below 2009 global financial crisis through valuation), as the sector tends to mean-revert over the longer term,” he added.

History shows low CPO spot prices usually last for about 6 months before price recovery sets in as producers cannot afford to continuously sell below cost over an extended period of time (Pic: TMRpic)

For stocks under its coverage, Ong prefers Sarawak Oil Palms Bhd and Ta Ann Holdings Bhd as they are trading near or below their 2009 valuations despite recent share price recovery, which suggest further upside.

In terms of Plantation Index members performance, out of the 43 companies, the investment bank found 14 companies (33%) now trade at less than 0.5 time price-to-book values (PBV), while 16 companies (37%) trade at between 0.5 time and one time PBV.

Maybank IB sets three key criteria for potential privatisation candidates — the stock is trading at less than one time PBV, is net cash positive and its major shareholders control more than 50% of the company.

There are six companies that met all three criteria which are Sungei Bagan Rubber Co (Malaya) Bhd, DutaLand Bhd, Kluang Rubber Co (Malaya) Bhd, Negri Sembilan Oil Palms Bhd, Riverview Rubber Estates Bhd and Hap Seng Plantations Holdings Bhd, the investment bank revealed.

“We are not suggesting they will be taken private, but prolonged under-valuation may trigger the process or even take-over by external parties and of these six companies, DutaLand is cash rich as it no longer owns any plantation estates following the disposal of its estates to Boustead Plantations Bhd in 2017,” Ong said.

Possible Industry Consolidation?

Factors that will drive demand for estate land include scarcity (especially in Peninsular Malaysia), property development potential (especially on the west coast of Peninsular Malaysia) and potential better return from other crops (on a per hectare basis) like durian.

“Granted the palm oil market is soft presently and returns barely attractive given low CPO prices, we anticipate entrepreneurs to seize the opportunity to bargain hunt and scout for opportunities previously not available during the commodity bull market,” Ong noted.

In addition, one push factor for smaller planters to seriously consider selling out is the rising cost pressures and shortage of workers.

“The lack of economies of scale compared to larger planters makes it increasingly hard to manage a small estate efficiently.

“This may drive industry consolidation and encourage more M&A activities down the road,” he said, adding that the firm expects robust M&A activities in 2019 as was the case over the last few years.

For the oil palm or plantation sector, based on data compiled from Bursa Malaysia, plantation land/estate and plantation-related transactions (ie buying plantation company instead of direct land deal) within Malaysia have totalled RM13 billion since 2012.

This is despite CPO price having peaked in the past decade.

The figure, however, excludes two major initial public offerings which raised a combined RM10.8 billion in cash between 2012 and 2014.

“Despite low CPO price which hit a 10-year low in November 2018, M&A interest did not waver.

“In 2018, by our estimate, the transactions in Malaysia were worth RM1.23 billion, a 75% decline from 2017 as 2017’s transactions of RM5.01 billion included RM3.19 billion worth of plantation land ‘settlement’ to offset inter-company loans (between Sime Darby Plantation Bhd, Sime Darby Bhd and Sime Darby Property Bhd) prior to the demerger of Sime Darby Bhd into three listed entities,” Ong said.

Excluding this inter-companies settlement, 2017’s transactions would have been RM1.82 billion, and 2018’s total transactions would have been lower by only 32% year-on-year.

The interest on M&A has not wavered, Ong said, as barely into 2019, a new deal worth RM175 million was announced.