March 04, 2020 / 05:30 PM / By Cordros Research /
Header Image Credit: New Food Magazine
Earnings at Risk on Falling Global CPO Prices
In our last sector update, we had forecast that both OKOMUOIL (CTP: NGN83.27/s) and PRESCO (TP: NGN47.67/s) to deliver EPS growth of 42.0% y/y and 23.5% y/y respectively in 2O20FY, underpinned by (1) volume expansions from newly matured plantations, and (2) a sharp CPO price increase, driven by shrinking CPO surplus picture. While our volume growth expectations remain intact, the coronavirus-induced decline in global commodity prices has forced a reassessment of our CPO price forecast. Given that the share prices of our coverage companies now respond swiftly to global CPO price movements, especially since the closure of the land border, there is a clear case for us to rethink our earnings estimates. In this report, we ascertain the impact of a sustained decline in prices to our forecasts.
Coronavirus is Wreaking Havoc
The outbreak of the coronavirus has resulted in global CPO prices shedding 25.3% YTD. If domestic prices were to mirror this move, our model suggests that average selling prices for both OKOMUOIL and PRESCO would decline by 19.3% y/y and 17.3% y/y, respectively.
Share Prices of Our Coverage Companies Have Not Reacted Much
Amid the commodities market pandemonium, OKOMUOIL's share price has gained 22.3% YTD, while PRESCO has lost 5.5%. On the former, we suspect that stronger performance in Q4-19, together with investors' optimism regarding the volume growth expectations over 2020E, aided the share price rally. For context, OKOMUOIL delivered double-digit revenue and EBIT growth in Q4-19. In our view, an uptrend in global CPO prices (+27.7% y/y), combined with the sustained closure of the land borders, paved the way for management to raise prices by Â¢.9% y/y.
Meanwhile, PRESCO disappointed in Q4-19, reporting 12.2% y/y and 71.3% y/y declines in revenue and EBIT, respectively. In our view, the benign volume growth expectation relative to OKOMUOIL was responsible for this, given fears of another round of earnings weakness, occasioned by the expectation of price erosion over 2020.
Any More Legroom for CPO Prices to Fall? In the event of an extended period and/or a worsening of the virus outbreak, it is tough to see any respite for CPO prices going forward. For one, demand from China (8.9% of global consumption) is expected to slow as more communities are quarantined. Meanwhile, the precipitous decline in crude oil prices is another pressure point, as it has reduced the competitiveness of Bio-diesel as an alternative fuel, and thus, led to a reduction in CPO demand. Worse still, India's (14.6% of global consumption) decision to restrict imports of refined palm oil and palm olein to support its own domestic producers is also negative for global demand, and by extension, prices.
Domestic Prices Should Follow Suit
Since domestic prices track global price movements, our key thesis is for a domestic CPO price erosion over 2020E. Based on our sensitivity analysis, and assuming our volume growth expectation is unchanged, a 15.0% y/y decline in average selling prices, could lead to slower earnings growth of +20.8% y/y for OKOMUOIL (prior estimate: +42.0% y/y) and faster decline in earnings of -18.0% y/y for PRESCO (prior estimate: -4.4% y/y). Ona share price basis, these translate to valuations of NGN76.20/share and NGN47.20/share, respectively.
2020 Is Now Solely A Volume Play; Bet on the Name with the Most Potential
OKOMUOIL remains our top pick in the sector. Based on our worst-case scenario of a 15.0% decline in domestic CPO prices, OKOMUOIL can still offer 13.0% upside from the last closing price (NGN68.00/share). We believe volume growth of 56.1% y/y, mostly from newly matured acreage in OKOMU extension Il, should be enough to neuter the impact of price erosion on OKOMUOIL's earnings in 2020FY, while PRESCO's volume is only expected to grow by 7.5% y/y. Thus, PRESCO's earnings should be more exposed to CPO price movements, based on our assessment.