Timber — Uncertainty in Japan's housing starts recovery

Timber sector
Downgraded to neutral (from overweight):
We believe that there is now increased uncertainty regarding the recovery of Japan housing starts going forward due to heightened risk of the global economy slipping into a double-dip recession. Japan, being an export-oriented economy, is likely to be severely affected if the global economy does slip into a recession, and this will once again weigh on Japan's housing starts. Bearing in mind that the recovery in Japan's normal housing starts could stall, we now view that the reconstruction activities of the earthquake disaster area would likely just help sustain Japan's housing starts over the next two years, leading to relatively flat growth.

Japan is the largest importer of plywood globally and its plywood prices and import volumes generally correlate with housing starts. Given our view that the growth in Japan housing starts will be relatively flat over the next two years, we believe that plywood prices would now likely to turn out to be lower than what we originally estimated. Hence, we have cut our average plywood price assumptions for the timber companies under our coverage by US$30 to US$40 (RM94.23 to RM125.64) per cubic metre for FY12-13.

We expect log prices for timber companies to remain stable at current levels of US$220/cubic metre-US$240/cubic metre till the end of the year, as Sarawak log production is usually lower in 4Q due to seasonal factors. Due to a weaker growth outlook for the global economy next year, we expect average log prices to ease by about US$20/cubic metre in 2012, down by 8% year-on-year. Nevertheless, our 2012 average log price forecast of US$220/cubic metre-US$230/cubic metre is still above the historical average (about US$180/cubic metre), given the still relatively robust demand from India and China.

We remain positive on Ta Ann and Jaya Tiasa, as both companies have significant oil palm plantations that are similar to midsized plantation companies. FFB production for both companies is set to rise significantly over the next few years due to increasing mature hectarage, and this will provide a major boost to their earnings going forward

The risks include: 1) lower-than-expected improvement in Japan's housing starts; and 2) price discounting from neighbouring countries with lower cost of production, resulting in lower exports from Malaysia to its major export markets.

After our earnings revision and changes in target PER for the timber division (from 11 to eight times CY12 timber earnings), recommendations for WTK and Lingui are downgraded to "market perform" (from "outperform"), while recommendations for Ta Ann, Jaya Tiasa and Evergreen remain unchanged. All in, we downgrade our call on the timber sector from "overweight" to "neutral". — RHB Research, Oct 7

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