Sarawak Oil Palms (SOP MK, FV RM7.09, Close: RM6.23)

Stock Name: SOP
Company Name: SARAWAK OIL PALMS BHD

Research House: OSK

Price Call: BUY

Target Price: 7.09

4Q Hitch Unlikely toResurfac

After SOP's share price retreated by as much as 4.3%following its poorer than expected 4QFY11 performance, we took a closer look atits results and sought management's clarification. In 4QFY11, the company washit by a lumpy refining capacity backlog in Sarawak which led to delays in CPOshipments and revenue recognition. This should, however, work to SOP'sadvantage once its refinery comes on stream in 2Q. In 4Q, it also paid outhigher performance-based employee compensation after a record year. As theseissues should clear in 1QFY12, SOP remains our Top Malaysian Plantation Buycall.

Delving into thenumbers.  SOP's 4QFY11 earnings werebelow expectations. Although 4Q revenue fell by a lower than expected 3.8%q-o-q and was 47.5% higher yo-y, the company's costs of sales jumped 12.8%q-o-q and 82.4% y-o-y, dragging down its earnings to RM43.3m (-42.8% q-o-q,-10.8% y-o-y). As both the higher than expected revenue and costs were asurprise and admittedly puzzling (CPO production  -9.3% q-oq, realized CPO price -7.0%, butrevenue was just 3.8% lower), we took a closer look at the numbers and soughtclarification from management.

Higher revenue andcost as SOP seeks suppliers. In anticipation of SOP's maiden refinerycoming on stream in 2QFY12, the company has been buying CPO from vendors to  blend with its own CPO for shipment (whichnaturally  raises  revenue as well as costs). The company'srationale was this would allow it to secure CPO suppliers for its refinerybefore it commences operation, on the understanding that a supplier who sells itsCPO to another refinery is unlikely to return to SOP when the company'srefinery starts running. CPO trading could actually intensify in 1QFY12 as SOPbuilds up its CPO supplier base. We find comfort in learning that this move didnot give rise to trading losses (SOP  infact  made a negligible RM0.1m profitfrom it).  That said, the  1QFY12 earnings should not reflect muchimpact on an absolute basis although margins would naturally narrow as SOPprogresses down the value chain. Some 30% of the company's refining capacitywill be utilized by third party CPOs.

Refining capacitybacklog. SOP sold but was unable to ship 13,000 tonnes of CPO in December2011 due a backlog in refining capacity in Sarawak. Assuming the same 4QFY11realized CPO price of RM2,943 per tonne and a 20% net profit margin, successfulshipment would have added RM7.7m to its earnings. Such issues should be resolved  once SOP's refinery in Bintulu begins operation. While Peninsular Malaysian refinersrely partly on Indonesian CPO, refineries in Sarawak have ample local productionto cater to their capacity. Contrary to its peers on the other side of theSouth China Sea, capacity underutilization at  SOP's refinery is thusunlikely to be an issue even if Indonesia's more favourable export taxstructure is taken into consideration.

Source: OSK188