SINGAPORE (July 11): If you thought 1Q18 was a challenging period for the palm oil industry, the outlook for 2H18 could be worse as market watchers worry about a production surplus in 2H18, due to seasonality and low production in 1Q18.

In 2Q18, crude palm oil (CPO) prices trended lower in 2Q18, and are down about 6% so far this quarter. As for Golden-Agri Resources (GAR), its share price is down about 16% from end March while the STI is down about 5% over the same period.

On the currency front, the IDR has also depreciated by about 5.9% against the USD with most of the loss happening in 2Q18. GAR’s sales to customers within Indonesia and China are denominated in their local currencies, while export sales for most of the group’s products and cost of certain key purchases are quoted in USD.

Purchases and operating expenses in Indonesia and China are mainly denominated in their local currencies. This should be accretive operationally to earnings, but the group is also exposed to currency translation risk as financials are reported in USD.

Based on the annual report, if the IDR weakens against the USD by 5% with all other variables remaining constant, the group’s pre-tax profit would have decreased by US$34.7 million in 2017 and US$30.9 million in 2016, likely impacted by translation losses. Recall that pre-tax profit in FY17 and FY16 were US$114.1 million and US$140.3 million, respectively.

In a Wednesday report, OCBC lead analyst Low Pei Han says supplies are likely to go higher into 3Q18 amid lacklustre demand, the 3Q18 price outlook by OCBC remains at MYR2,250/MT with downside risks. A recovery to the MYR2,400/MT level is forecast into year-end as supplies dwindle then.

Over the long term, however, GAR believes that CPO prices will be supported by growing food demand as well as from increasing biodiesel usage.

“With weaker CPO prices and a dimmer outlook on earnings, we lower our valuation to 17x FY19F earnings and our fair value estimate drops from $0.34 to $0.30,” says Low.

As at 12.54pm, shares in GAR are down 1 cent at 28 cents.