SG Commodities Sector

Commodities Sector

 
Still UNDERWEIGHT for now
● Likely sluggish commodity prices
● Sentiment may remain cautious
● Maintain UNDERWEIGHT for now

Worst performers in 2012
Ever since we downgraded the commodities sector to Underweight last year on the back of an increasingly gloomy global economic outlook, commodities stocks were among the worst performers in 2012. Against the STI’s 18% jump until 11 Dec, the commodities stocks under our coverage fell by an average of 16%.

Still no light at the end of the tunnel
And with the major economies still looking somewhat shaky, we think that there may still be no light at the end of the long dark tunnel, or at least not in the first half of 2013 anyway. The International Monetary Fund (IMF) in its latest World Economic Outlook (WEO) report recently noted that there is now a one-in-six chance of global growth falling below 2%, which would be consistent with a recession in advanced economies and low growth in emerging markets and developing economies.

Commodity prices could remain sluggish
With the risk of a serious global slowdown still looking alarmingly high, the IMF expects

Commodities sector - supply chain managers

We maintain our Underweight rating on the Commodities sector with stock ratings and EPS intact. Among the supply chain managers, Mewah remains our key Underperform; Olam remains an Outperform for its earnings defensiveness vs. peers.

What Happened
Sentiment at the Asia Mining/ Commodities Trade and Finance World Asia Conference was distinctly less exuberant than a few years ago. Experts warned of moderating growth in commodities demand owing to slowing global economic growth and China’s soft landing, while insiders warned that demand-supply imbalances among certain commodities such as steel and iron ore could send prices

Expect Olam to outperform its hard commodity peers

Pushing upstream into rice farming and milling. Olam International Limited recently announced that it will be investing US$49.2m to set up a 6k hectare (ha) greenfield, fully integrated, mechanized and irrigated paddy farming and rice milling facility in Nigeria. Management intends to carry out the farming operations in a phased manner between the last quarter of FY12 and FY16. Olam estimates that the peak yield could hit 10 metric tonnes (MT) per ha (over two annual crop cycles) and provide 60k MT of paddy annually to the rice processing facility; this would in turn be converted into 36k MT of milled rice to be distributed through its existing network of distributors and dealers across Nigeria. Olam intends to fund the move via a combination of internal accruals and borrowings.

Also expanding its wheat milling facility in Nigeria. Separately, Olam also announced that it will be investing US$50m to expand its wheat milling capacity at Crown Flour Mills (CFM) in Nigeria, which already ranked among the three biggest wheat millers in the country. The investment will lead to (a) the addition of a semolina mill and a flour mill in Lagos, each of 250 MT per day (TPD); and (b) a 250 TPD flour mill in Warri, taking the total installed capacity from 1,630 TPD to 2380 TPD; and (c) increased silo storage space to accommodate an additional 18k MT of wheat storage across Lagos and Warri. Olam expects the construction and commissioning of the investment - which it will fund using internal accruals - to take 17 months.

Moves will focus on more basic food space. We view the latest moves positively as it would allow Olam to move further upstream into the more basic food commodities space, which should continue to remain fairly resilience even in a global economic slump. However, we note that these investments will take some time before they can contribute meaningfully to the bottom line; and may even be a mild drag on operations due to the initial start-up costs. But in the grand scheme of things, we do not expect them to have much impact either way for now. Hence, we intend to leave our estimates for both FY12 and FY13 unchanged for now.

Maintain HOLD with lower S$2.05. But in line with the weaker overall outlook, we lower our valuation peg from 18x to 14x (or one standard deviation below its 5-year average); and this drops our fair value from S$2.63 to S$2.05. Maintain HOLD as we expect Olam to outperform its hard commodity peers despite weaker economic prospects. We would be buyers at S$1.85 or lower.

Industrial REITs and Commodities Sector

Industrial REITs: Resilience to continue in 2012

Industrial REITs displayed resilient performances. Industrial REITs have proven its defensive nature YTD, having generally outperformed both the broader REIT sector and STI. For the financial quarter ended 30 Sep, we note that all the industrial REITs had registered healthy YoY growth in their financial performances. On the operational level, they also put up a strong showing. Overall portfolio occupancy as at 30 Sep came in at a high range of 94.5-100%, relatively unchanged from 94.3-100% range in the prior quarter and 95.3-100% range seen the same periods for 2009-2010. The weighted average lease expiry (WALE) for a number of REITs had declined somewhat over the past two years. However, this is still healthy in our view as the percentage of the leases expiring is generally well spread out.

Expecting cautious stance in 2012. Going into 2012, we expect the industrial REITs to adopt a more cautious stance on their acquisition plans. The global economy, by far, has been plagued with great uncertainty, with a number of indicators biased towards a likely moderation in economic activity in 2012. In Singapore, we observe that the economy may have already been bearing the brunt from the economic malaise, with the manufacturing sector showing contraction for the fifth consecutive month in Nov. While we do not anticipate any drastic change in lessees' financial health and occupancy among the industrial landlords' rental space, we believe these developments may likely induce them to take on a more cautious stance and be more selective on their acquisition plans. On a brighter note, despite the lower expected investments, we still anticipate industrial REITs to rake up a good set of financial performance in 2012, thanks to their proactive approaches on investment/ asset enhancement activities over the past year, built-in rental escalations and possibly further positive rental reversions.

Maintain OVERWEIGHT. We continue to maintain our OVERWEIGHT view on the industrial-REITs subsector. Industrial REITs, we note, offer one of the highest DPU yields in the REIT space. This is in addition to the relative stability and earnings visibility in their portfolio, backed by longer term leases, diversified tenant base and security deposits. In addition, they now have stronger financial positions and greater access to capital, unlike the difficult times seen in the global financial crisis. We maintain our BUYs for A-REIT and MLT, and single out CACHE as the preferred pick for this subsector, due to its strong master lease arrangement, healthy leverage ratio of 30.4% and attractive DPU yield.

-->
Commodities Sector: Downgrade to UNDERWEIGHT - risks outweigh rewards

Gloomy global economic outlook. The International Monetary Fund (IMF) has revised down its global economic growth forecast for 2012 in its latest World Economic Outlook (WEO) report, citing renewed financial instability, driven by concerns about developments in the euro zone and the strength of global activities, especially in the US. While the IMF believes that the return to stronger activities in advanced economies is delayed rather than derailed by the turmoil, this is based on the assumption that policymakers keep their commitments and the financial turmoil does not run beyond their control. Separately, OCBC Treasury Research & Strategy (OTR) expects the global economy to decelerate further, with things getting a lot worse in 1H12 before they get better in 2H12.

Asia is likely not spared. Meanwhile, IMF also estimates that a global downturn could impact Asia-Pacific growth by 1.5-4% relative to baseline in the absence of policy responses. Already, we have seen continued weakening in China's manufacturing data as well as export numbers. In fact, the Asian Development Bank (ADB) now sees Singapore, Hong Kong and China among the worst-hit economies in the latest global economic crisis, noting that the external environment for emerging East Asia has worsened since mid-2011. Likewise, OTR notes that the previous 2008-2009 global financial crisis had highlighted the macro-financial vulnerabilities inherent in Emerging Markets (EM), including Asia.

Commodity prices could ease more. And the IMF is forecasting a continued decline in commodity prices in 2012 as the downside risks to global growth have risen; although it notes that price spikes due to supply factors remain the main concern. Meanwhile, we also note the divergence in views among the various commodity players. For example, soft commodity players such as GAR, WIL and Olam continued to maintain pretty resilient outlook, citing the defensive nature of their consumer staple businesses. However, hard commodity plays are generally more muted, especially for those dealing in industrial metals, as industrial demand/output typically slows during economic contraction. Certain agricultural commodities like rubber and cotton may also be adversely affected should people cut discretionary spending.

Downgrade to UNDERWEIGHT. Renewed weakness in the US economy and uncertainties over the EU sovereign debt issues have exacerbated the risk of the economy slipping into a "down cycle". For these reasons, Singapore has recently pared its 2012 GDP growth forecast to 1-3%, down from the expected 5% in 2011. But we could still see a faster-than-expected deterioration in the global economies, especially in China. As the looming downside risks could outweigh any potential rewards in 2012, we downgrade the sector from Neutral to UNDERWEIGHT. Our pick in the sector is Golden Agri.

-->