This article first appeared in The Edge Malaysia Weekly, on October 12 - 18, 2015.

MORE of Sarawak Oil Palms Bhd’s (SOP) palm trees will enter their best production period soon, which could give it a larger harvest if crude palm oil (CPO) prices stay buoyant.

“The average age of our palms is about nine years, so the yields are expected to grow on a year-to-year basis for the next four years,” SOP group chief operating officer Eric Kiu tells The Edge.

“Palms aged 10 to 15 are usually the highest yielding. We have had some [in that age range] that yield as much as 26 tonnes of fresh fruit bunch (FFB) per hectare,” he says.

That’s way above the national average of 18.63 tonnes last year and the average of 16.13 tonnes for Sarawak, according to data from the Malaysian Palm Oil Board. Those very productive palm trees also well exceed SOP’s (fundamental: 0.80; valuations: 0.80) own average FFB yield of 17.5 tonnes per hectare in 2014.

Kiu explains that SOP’s yield was low in 2013 and 2014 as its young and immature palms brought down the group’s overall yield, but that will change with more of its trees entering their prime.

“We expect a general improving trend from here on out. On a year-to-year basis, we expect SOP’s second half (2HFY2015) FFB yields to be about 8% to 9% higher than last year,” says Kiu.

The third quarter is seasonally more productive for planters, and this is reflected in SOP’s forecasts compared with the 3% year-on-year (y-o-y) FFB growth it showed in 1HFY2015. Its oil extraction rate of 20.26% in FY2014, however, is expected to remain flat or make a marginal improvement.

That said, CPO prices, the ringgit’s movement and global economic conditions remain the key factors dictating the size of profits for planters like SOP.

Its latest 1HFY2015 took a hit from lower CPO prices, dragging net profit down 66% y-o-y to RM22.5 million, although revenue rose 16% to RM1.4 billion on higher volumes.

The benchmark three-month CPO futures contract averaged about RM2,200 per tonne for much of the year. It traded in the RM2,000 to RM2,300 range this year, before sliding to a low of RM1,867 following the Black Monday selldown on Aug 24.

But as renewed El Niño concerns caught hold, prices jumped to as high as RM2,451 per tonne on Sept 29, on expectations of weaker production. For many analysts, that price point is the short-term maximum level, capped by competition from soyoil prices. Last Thursday, as the ringgit mustered some ground, December 2015 CPO futures fell RM43 to close at RM2,276 per tonne. Similarly, March 2016 contracts ended at RM2,357, down RM38 per tonne.

A full-blown El Niño, if it happens, would be a sure catalyst for CPO prices.

“An El Niño would take prices well above US$700 (RM2,970 as at last Thursday’s exchange rate) by mid-year, with world CPO output in 2016 below that of 2015,” James Fry, chairman of commodities consultancy LMC International, said at the industry conference Globoil India two weeks ago.

Even without an El Niño, Fry believes CPO could exceed US$600 as Indonesia’s planned increase of palm oil-based biodiesel would also reduce global supply.

SOP’s Kiu is not betting on large CPO price increases ahead, but is optimistic about a better 2016.

“We expect [CPO] prices to be rangebound for now. Generally, we are expecting next year to be a better year in terms of the year average,” SOP’s Kiu says. “As for El Niño, we are seeing a drier year here in Sarawak, but we expect that it will not be so strong for Sarawak,” he adds.

There should only be a small impact on production, but Kiu notes that the company is watching as the weather develops. “The next two years will still remain challenging but we expect profitability in the following few years to be better,” Kiu says.

SOP expects some 8,200ha or 13% of its planted land to come into maturity over the next two years. Currently, close to 78% of its planted land in Sarawak, spanning 63,400ha, is mature. It has another 3,000ha there suitable for planting and it is in the process of getting approvals from relevant parties, says Kiu.

Eventually, SOP is hoping to be a 100,000ha-size planter, but has not set itself a specific timeline. It is keeping a lookout for greenfield and brownfield acquisitions in Sarawak and has no plans to move beyond the state anytime soon.

SOP has RM471.5 million in cash as at June 2015, and will have net debts of RM584 million once borrowings are accounted for. This gives it a debt-to-equity ratio of 0.7 times, a level it is comfortable with, Kiu says.

The company has been consistently paying out dividends: five sen per share in FY2011, six sen in FY2012 and FY2013 and five sen last year for a yield of 1.05% as at last Thursday’s close. Kiu declined to comment on future payouts. At the time of writing, Bloomberg data showed analysts projecting 3.8 sen dividend for FY2015 ending December before moving up to 5.1 sen for FY2016 and 6.5 sen for FY2017.

As with most other planters, the stock has had an unlucky year due to the weak commodities market and an uncertain global economy, which hit CPO demand.

Since January, the shares have plummeted as much as 36.6% to RM3.68 on Aug 25, following Black Monday. But increased demand for CPO on the ringgit’s weakness helped return interest to the stock, which shot up 30% to RM4.80 a month later. It closed at RM4.76 last Thursday.

The five analysts tracking SOP are split on whether there is more upside potential for the stock, which is trading at 28 times projected earnings for this year. There were two “buy” calls, two “sell” and one “hold”, Bloomberg data show.

Kenanga Research is the most bullish, with its RM5.90 target price pointing to 23.95% upside potential from last Thursday’s RM4.76 close. Similarly, Maybank Investment Bank Research’s RM5.23 target price implies 9.87% upside. Still, if one were to believe RHB Research Institute’s valuation of RM4.84, there is limited upside of only 1.68%. Worse, UOB Kay Hian Research values the company at only RM3.85 per share — implying a 19.1% slide.

The wild card here may well be favourable weather conditions — be it a full-blown El Niño that hampers production but buoys CPO prices, or blue skies. Whatever the case, planters that can keep their costs in check will remain profitable with CPO prices expected to stay well above RM1,500 a tonne.

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