This is the best plantation play on any US-China trade war hit to soybeans: Deutsche Bank

Singapore two-dollar bills

If China proceeds with proposed tariffs on imports of U.S. soybeans, that could push up crude palm oil (CPO) prices, but traders shouldn’t get too excited about playing the move, Deutsche Bank said in a note on Friday.

“Near-term transition of Chinese edible oil import substitution to crude palm oil (CPO) to fill soy oil vacuum could drive up near-term CPO prices but this would not be sustainable,” the investment bank said. “The negative impact of trade barriers goes along the supply chain from planters to consumers, depending on the actions taken.”

But it noted that if China transitions to palm oil, that could ease the projected “abundant” harvest of CPO expected in the second half of this year, providing a floor price support.

Deutsche Bank noted that U.S. farmers are in a “very sensitive” period as they enter the planting season and begin to sell forward a third of their projected harvest, even as the uncertainty over a potential trade war is likely to limit buying interest.

Concerns on Wilmar

It pointed to plantation play Wilmar, which is a soybean buyer for its China-based crushing operations.

“Wilmar needs to get soybean from Brazil’s current record harvest but only sufficient to last till August 2018. This might force Wilmar to pay a premium for U.S. soybean and put downward pressure on crush margins and this could worsen after August 2018,” it said.

“On trade war risk, we are cautious about Wilmar and neutral on CPO planters,” it said, noting Wilmar’s China-related business faces “many uncertainties.”

The ‘best proxy’

But the bank pointed to one stock as the “best proxy” to play the trade war, and afterward: First Resources.

“Waning capex, low production cost plus rising output prospects as estates mature spell out a growing free cash flow yield and more room to hike dividend per share — factors that make First Resources a good investment even in a low CPO price environment,” it said. But it added, that the CPO price would still ultimately drive the share price.

It said the plantation sector valuations as a whole remained “unattractive” in a weak CPO price cycle. For its estimates, it assumed a sector target price-to-earnings ratio of 13 times, based on a 2018 average CPO price assumption of 2,500 ringgit per MT.

“If the spot CPO price falls from current levels for the rest of 2018, we see downside risk to our and consensus earnings. Meanwhile, most planters still trade at 15 times, implying a derating potential,” it said.

Deutsche Bank rates First Resources at Hold with a S$1.80 target price, and Wilmar at Hold with a S$3.20 target price. It rates Golden Agri Resources at Sell with a S$0.30 target.

Its top sector pick was Malaysia-listed KL Kepong, rated Buy with a 30 ringgit target price.

Wilmar ended Friday up 1.94 percent at S$3.16, First Resources was down 1.17 percent at S$1.69 and Golden Agri was flat at S$0.345.