Rubber rich plantation firms to deliver better returns – JKSB

Given the global markets dynamics plantation companies with heavy exposure to rubber is expected to outperform those that are predominantly tea producers says a new update on the plantation sector by John Keells Stock Brokers. Here are excerpts from the research report:

Sri Lanka’s plantation industry has witnessed mixed fortunes with the tea industry exhibiting increasing volumes amidst subdued prices while the rubber industry has enjoyed soaring prices accompanied by an increase in output.

According to the statistics available, Sri Lanka’s tea production during 1‐3QCY10 grew 19% to 247 million kgs with medium grown teas recording the highest yoy growth of 30%. The low grown segment production reached 146 million kgs, an increase of 18% while the high grown segment saw a 12% yoy growth in output. This was attributable to favourable weather conditions, better use of fertilisers and a lack of labour unrest that affected production last year.

Increased tea production in Sri Lanka has exerted downward pressure on tea prices which have dropped at least 2% since the beginning of the year. The high grown and the medium grown teas witnessed an 8% drop from the beginning of the year while the low grown prices fell only 1%.

Tea production from countries such as India and Kenya are too on the rise with South India recording a growth of around 6.5% up to August 2010 while North India saw a decline of around 4.6% in production due to adverse weather conditions and pest attacks. Tea production in Kenya has also seen significant improvement with output rising by 43% from January to August thanks to better weather conditions. With winter buying from countries such as Russia and CIS having come to an end, the Sri Lankan tea averages are likely to see a downward movement which will narrow the gap between the NSAs recorded in Sri Lanka and elsewhere.

On the other hand, rubber production in Sri Lanka has also improved considerably with quantity reaching 98.1 million kgs from January – August 2010, up 9% yoy. It is believed that the global natural rubber supply shortage will worsen during the 4QCY10 as unfavourable weather conditions disrupt production from key growers such as Thailand. Increase in crude oil prices, growing demand for natural rubber from countries such as China, India and Malaysia coupled with tightening supply is expected to push rubber prices further.

Rubber prices in Sri Lanka too have followed a similar trend with average rubber prices having nearly doubled over the prices recorded in 2009. Average price of RSS 1 up to September 2010 increased approximately 25% over those recorded in 2008 during the commodity boom.

Global palm oil prices have too remained high with average price per MT growing by 25% over 1‐ 3QCY10. Output in Indonesia and Malaysia, which together produce 90% of the world’s palm oil has been affected by the dry weather conditions.

Outlook

Although tea prices have dipped on the back of an increase in supply, the prices have remained remunerative from the point of view of the plantation companies. However, with constant increase in cost of production, tea producers are expected to realise falling margins. Rubber plantations on the other hand, exhibit significant potential given the global shortage in rubber supply and increase in demand from East. Given the above, we expect the plantation companies with heavy exposure to rubber to outperform those that are predominantly tea producers, thereby delivering higher returns to equity. The table indicates the composition of output among the listed plantation companies.