This article first appeared in The Edge Financial Daily, on March 23, 2016.

IOI Corp Bhd
March 22 (RM4.96)
Maintain hold with a higher target price (TP) of RM4.45: According to Bloomberg, the Roundtable on Sustainable Palm Oil (RSPO) complaint panel will recommend the RSPO board of governors to suspend IOI Corp Bhd’s RSPO certification until an action plan has been submitted and accepted by the RSPO, and that a peer review of high-conservation value assessments has been performed.

To recap, IOI was alleged for non-compliant with some of the RSPO’s rules on possessing environmental permits, clearing fragile land in Indonesia. We view this as a potential downside risk to IOI as a suspension of its RSPO certification would impact its downstream operation. Its customers, especially those in the European Union and the United States, might switch to other suppliers to comply with their sustainability policies.

IOI’s downstream operation accounted for about 30% of its total financial year 2015 operating profit. We understand that IOI will submit its action plan to the RSPO within the next two weeks. It is also seeking for clarification on the scope of suspension whether it applies to the group as a whole or only applicable to the certification of new developments. Nevertheless, the RSPO board is expected to make a decision on this issue in next few weeks.

IOI’s downside risks are weaker-than-expected fresh fruit bunch output, escalating crude palm oil (CPO) production cost, weaker-than-expected recovery in edible oil demand and prices, and also the RSPO certification suspension.

While the RSPO issue appears to be a downside risk to the company, we make no change to our earnings forecasts for now pending clarification. To reflect the current CPO price upcycle, we tweak our price-earnings multiple for its plantation business higher. If history is a guide, a rising CPO price trend tends to lead to higher valuation of IOI, given the strong correlation between its price-earnings ratio and CPO prices.

IOI’s positives are its decent balance sheet and strong cash flow-generation ability. Its negative is its pricey valuations. Post-adjustment to valuation parameters, we maintain “hold” on IOI with a higher TP of RM4.45 (from RM4.15) based on sum-of-parts valuation. — HLIB Research, March 22