JP Morgan yesterday made a sharp reversal in its recommendation on the Malaysian plantation sector, raising its rating to overweight from underweight previously.
This follows the latest confirmation from US National Oceanic and Atmospheric Administration (NOAA) that the El Nino weather phenomenon has arrived and would last until early next year.
Expecting the crude palm oil (CPO) to hit a price of between RM1,800 and RM2,000 in the first half of next year, the US-based research house is now calling a buy on plantation companies under its coverage, including IOI Corp Bhd, Kuala Lumpur Kepong Bhd (KLK), Golden Hope Plantations Bhd (GHope), and PPB Oil Palms Bhd.
JP Morgan said there might be a short-term weakness in palm oil prices in October due to inventory correction in China. Recently, China has been stocking up on edible oils ahead of the Oct 1 deadline for stricter soybean oil import requirements that might disrupt supplies from South America.
But it expects the onset of El Niٌo to drive an upward trend in palm oil prices in the next six to nine months, and with prices possibly peaking in the first half of 2005.
“The share prices of plantation stocks are highly correlated to the direction of palm oil prices,'' it said in a report dated yesterday.
NOAA, in a news release on Sept 10, confirmed that El Nino conditions had developed in the tropical Pacific Ocean and were expected to last through to early 2005. However, the agency said the phenomenon was weaker this time around.
El Niٌo is associated with changes in sea surface temperatures in the tropical Pacific Ocean and can have significant impact on weather around the world, leading to severe drought in the West Pacific region and heavy rainfall in the Eastern Pacific area.
El Niٌo episodes occur about every four to five years and can last 12 to 18 months.
JP Morgan said its top pick for the sector is small-cap PPB Oil, which it believes has the best growth potential given its attractive plantations profile, as 53% of its estates are located in high-yielding Sabah. In addition, 52% of PPB Oil's estates are young – at below the prime yielding age – indicating strong production and earnings growth potential over the next two to three years. JP Morgan has set a price target of RM4.50 on PPB Oil.
“Among the larger caps, we like Golden Hope for its attractive valuations and the extra return from the distribution of Island and Peninsular Bhd (I&P) shares – of 0.4 I&P share for every GHope share – expected before end-2004. It has set a price target of RM4.50 for GHope.
JP Morgan added that any reform in government-owned corporations (GLCs) may enhance the price target by 18% to 19%, although the probability of that occurring was low at this stage. “The key risk to our price target is if El Niٌo dissipates unexpectedly before end of this year,'' the report said.
As for IOI Corp, JP Morgan said although the stock has outperformed the market significantly over the last three months, it believed there is more upside as palm oil prices have yet to see any impact from El Niٌo. The research house has set a price target of RM11.50 for IOI Corp.
JP Morgan said KLK, with a net cash of RM500mil, has the strongest balance sheet among plantation companies under its coverage.
“We believe this cash position is excessive, and investors would prefer to see better capital management from the company, perhaps through a higher dividend policy,'' it said. JP Morgan has set a price target of RM8.50 for KLK.