First Resources - Buoyed By Strong Sales Volume And Stable Downstream Margin

3Q22 Preview

FR's 3Q22 results announcement is scheduled to be released on 14 Nov 22 before market opens. Based on our current estimates, we expect FR to report a core net profit of US$55m-60m for 3Q22 (2Q22: US$54m; 3Q21: US$53m). Key items to look out for are:-

a) Lower upstream margin due to lower CPO ASP and higher cost (mainly from fertilisers). In 3Q22, Indonesia's CPO domestic prices hit as low as Rp7,100/kg in Jul 22 before recovering to Rp10,000–11,000 in Sep 22.

b) Stronger sales volume. We expect a strong sales volume with the high inventory carried forward from 2Q22 and also the recovery of Indonesia palm oil exports as the government is slowly relaxing the exports control.

c) Better refining margins. Indonesia's refining margins remain steady because refined product prices did not fall as much compare with CPO prices traded domestically in Indonesia. Recall that part of the refining margin derived from the export duty and levy is spread between crude and refined palm products, where crude is usually taxed at a higher rate vs refined palm products. As CPO prices fall and the export levy is temporarily suspended, the gap has narrowed from an estimated range of US$96-100/tonne in 1H22 to US$48-96/tonne in 3Q22.

Stock Impact

Strong sales volume. We expect a strong sales volume with a high inventory carried forward from 2Q22. FR's inventory build-up as of end-Jun 22 was 131,000 tonnes, which is its record high (the highest inventory build-up was around 60,000 tonnes). With the Indonesian government encouraging palm oil exports since Jun 22 and more relaxation in the Domestic Market Obligation (DMO) and the Flush Out programme, we expect strong sales volume, especially in its refined products in 3Q22. On top of that, we anticipate better biodiesel sales as well, thanks to cheaper palm oil biodiesel vs gasoil which led to higher export sales.

Inventory level is still higher than average. Recall in 2Q22, most of the Indonesian plantations companies did not take in third-party FFB/CPO as most of the storage tanks were full where FR had also hit its record-high inventory level in 2Q22. Despite the stronger sales volume for 3Q22, FR's inventory may still be at a higher-than-average level in 3Q22 because it resumed its FFB purchase from third parties and also had higher production from its own estates in 3Q22. This is not a concern to us as these inventories could translate into sales in 4Q22 when production enters the low season.

Delay in fertiliser application. We reckon that the fertiliser application may still be delayed in 3Q22, mainly due to the unfavourable weather in Indonesia. On top of that, the high rainfall season is still continuing in 4Q22 with floods happening in Kalimantan (31% of FR's estates are in Kalimantan). Hence, we suspect FR would not be able to fully apply its fertiliser as per its initial target.

Earnings Revision/Risk

Maintain earnings forecast. Our net profit forecasts for 2022-24 are at US$247m, US$229m and US$231m respectively.

Valuation/Recommendation

Upgrade to BUY with the same target price of S$1.70. FR's share price had declined by 14% since our last downgrade in Jun 22. This has could have factored in the negative earnings impact from the Indonesian policy changes. We upgrade to BUY as we see stable downstream performance which will mitigate the CPO downtrend in 2H22 and 2023.

High dividend yield of 6-7%. On top of that, FR has a generous dividend payout policy with of up to 50% of its underlying net profit starting from 2022 (previous: 30%). With our assumption of 50% dividend payout ratio, this translates to a stable dividend yield of 6-7% for 2022-24 despite our lower CPO ASP assumption for 2023-24 at RM4,000/tonne (US$848/tonne). (2022: RM5,200/tonne which is equivalent to US$1,1023/tonne).

Share Price Catalyst

Stronger-than-expected CPO price recovery.

Higher-than-expected FFB and CPO production.