Focusing on upstream business
LSIP is still focused on the upstream business of palm products and rubber. Rubber price has declined by -5.7% YTD in 2016, due to slowdown in commodities price and global slowdown in auto market, i.e. Ford and GM has closed its branches in Japan and Indonesia. However this segment has been decreasing as proportion of total sales volume to 2.2% in 9M15 (9M14: 2.0%, 3M15: 2.8%), shifting partial land for palm products with better margin could be LSIP option. Meanwhile palm products dominate sales volume at 96.3% in 9M15 (9M14: 97.1%; 6M15: 96.3%), with breakdown of CPO and palm kernel of 76.5% (9M14: 78.0%; 6M15: 76.9%) and 19.9% (9M14: 19.1%; 6M15: 19.4%) respectively. Going forward LSIP will focus on upstream business to support its parent company, note that EBITDA margin for palm products almost 21% vis-à-vis 5% for downstream business in 9M15. Giving preference to LSIP strategy, despite we estimate that CPO selling price will remain flat in 2016.
Production improvement on the back of favorable age profile
LSIP reported substantial improvement in 3Q15 FFB nucleus production to 382k tons (+6.3% YoY; +7.3% QoQ), quarterly improvement backed by favorable age profile (prime age: 14-21 years), translating to 9M15 production to 998k tons (-1.2% YoY) where this flat growth was caused by drought in 1Q15 and companies believed 2015 production to reach around 1.3-1.4mn tons. Interestingly FFB processed in 9M15 increased to 1.5mn tons (+4.8% YoY), supported by external fruit purchases of nearly 500k tons (+19.2% YoY), we expect that drought forged LSIP to obtain external supply to be refined. Production yield has been depressed to 12.7 ton/ha (3Q14: 13.2 ton/ha; 2Q15: 7.8 ton/ha), followed by lower CPO yield and Rubber yield of 3.0 tons/ha and 0.7 tons/ha respectively. LSIP has different seeds profile compared to others, leading to better CPO and Palm Kernel extraction rate of 23.1% and 5.9%.
Preference to organic growth
LSIP has a sizeable land bank of around 10,000 ha, which will be enough for companies to fulfill its planting target for 4-5 years. Note that LSIP targets shallow planted area of around 2,000 ha in 2016, due to negligence management to minimize weather risk and efficiently manage its salary expense, i.e. South Sumatra and East Kalimantan. In addition, its strong balance sheet and less exposure to forex transaction and loan could help them to acquire plantation companies with cheap valuation and bringing synergy to company.
Maintain BUY rating with TP of Rp 1,545
As we see better outlook on palm products industry to stabilize the CPO price, we maintain our BUY rating with TP of Rp 1.545 based on 2016 implied PER of 12.0x for LSIP. The stock has also underperformed the JCI by -14.8% within 3 monthswhile it has a clean balance sheet. Downside risks to our call include more attractive substitute commodities (i.e. Soybean oil) and government higher CPO export tax program to support budget.