Support in transitioning towards sustainability would be the best way forward for the palm oil industry, said Credit Suisse after determining that there is a lack of commercially available alternatives to progress as the UN sustainable development goals’ deadline of 2030 looms.
In a report, Credit Suisse' environmental, social and governance (ESG) research analysts Amanda Foo, Phineas Glover, Alfred Chang and Samuel Pratama noted that investor engagement — rather than divestment — in supporting the palm oil industry's transition, would spur the sector forward in light of palm oil’s inherent benefits compared with other crops, which include its “unrivalled productivity" in being three times more productive, ability to alleviate poverty, as well as being a healthy food source.
The analysts said that the sector’s ongoing environmental and social concerns as “one of the most controversial crops” in a time of where sustainable investing has gained momentum globally, had caused the sector to trade at record-low price earnings (PE) valuations today.
“The sector trades at a 72% discount to its peak PE today, wider than the 60% average of other ESG-excluded names. As the focus shifts from divestment to engagement on transition, we believe this steep discount will incrementally be removed for sustainability leaders due to the viability of sustainable palm oil,” the analysts said.
Cultivation of palm oil has been commonly associated with deforestation and climate change concerns, and more recently, labor exploitation issues.
Palm oil, which accounts for 36% share of global vegetable oil production, plays a key role in meeting food demand.
The world’s population is estimated to grow to circa 10 billion by 2050, which will require another 100 million tons of vegetable oil for food needs.
“Being the most productive oil crop (at least three times more productive compared to other crops), we see palm oil playing a key role in fulfilling global food security. Planting alternative crops would increase the risk of deforestation, as more agricultural land would be needed (five to seven times more land to meet food demand in 2050). Palm oil has also helped alleviate poverty among major producing countries Indonesia and Malaysia by providing much-needed jobs and higher income to rural communities.
“Given the lack of commercially available alternatives and the increasingly pressing sustainable development agenda [UN SDG goals to be attained by 2030], we opine that transition support would be the best way forward for the industry. More companies have commitments for palm oil (71%) today compared to other agricultural products such as soy (31%) and beef (28%),” they said.
The analysts noted that higher commitment would pave the way for higher accountability and better industry practices, which should help to accelerate the transition.
Currently, the most complete and effective certification standard, they said, can be found in the Roundtable on Sustainable Palm Oil RSP; however, it remained a “perfectible standard”.
In order for the industry to become more sustainable, they noted there was room for improvement in addressing labor and social risks, smallholder incorporation and certified sustainable palm oil uptake.
According to data from Refinitiv’s Institutional Brokers Estimate System, Bloomberg Professional Services and Credit Suisse, in terms of price-earnings (P/E) ratio derating, Wilmar International (-18%) ranked favorably against key ESG pressures, followed by Kuala Lumpur Kepong Bhd (-59%), while Indonesia’s PT Astra Agro Lestari Tbk (-88%) and Sime Darby Plantation Bhd (Sime Plant) (-85%) lagged their peers. The latter, however, they said, stood out in terms of governance based on data from Refinitiv, an American-British global provider of financial market data and infrastructure.
The analysts also point out that planters had been undervalued amid favorable crude palm oil (CPO) price prospects.
“Planters currently trade at 24% below replacement cost with significant discount seen in upstream planters. We note landbank appreciation prospects in stringent new planting certification standards and reforestation potential.
“Separately, palm oil price is rebounding to multi-year highs on the possible re-emergence of La Niña,” Foo said, upgrading Sime Plant to “outperform” from a “neutral” call previously and raising its target price to RM4.40 from RM3.43.
She added that Sime Plant was now trading at an undemanding FY21E P/E of 12 times – 13% below regional average – and was the most leveraged to upside surprise in CPO price.
“Its 100% Roundtable on Sustainable Palm Oil (RSPO)-certified landbank and good governance make it a potential beneficiary of future ESG inclusion,” Foo said.
Meanwhile, Foo expects Genting Plantations Bhd to benefit from improved earnings prospects, following the revision in Indonesia’s export levy scheme effective July 2, which brought the selling price in the nation to “an estimated RM3, 280 per ton, 11% higher than the previous duty structure”.
“This bodes well for Genting Plant as 58% of its planted area is situated in Indonesia. Should CPO price average RM4, 000/t throughout 2021, we estimate 44% earnings upside for Genting Plant, the second highest within our coverage,” Foo said, ascribing the stock with an “outperform” call and giving it a target price of RM8.90.