Commodities Sector - 2QCY11 scorecard; downgrade to NEUTRAL (OCBC)

Downgrade to Neutral

Soft commodity plays did better in 2Q11. From the recent conclusion of the second quarter results season, we note that soft commodity plays under our coverage generally did better. For example, Wilmar International Limited (WIL) posted 1H11 revenue of US$20,096.5m, meeting 56% of our FY11 forecast, while adjusted net profit of US$811.7m met 48% of our fullyear estimate. Golden Agri Resources' (GAR) 1H11 revenue of US$3,063.5m met 76% of our FY11 estimate and net profit of US$380.4m met 63%. On the other hand, hard commodity plays like Noble came in slightly under; 1H revenue of US$39,719m met 52% of our original FY11 estimate, but core net profit of US$309.0m met just 31%.

2H11 outlook slightly mixed. Soft commodity player such as GAR and WIL continue to maintain pretty resilient outlook for the rest of 2011, both citing the defensive nature of their consumer staple business. They also expect their plantation businesses to continue to do well, buoyed by the still-high CPO prices as well as the expected increase in CPO production in 2H11. On the other hand, we note that the hard commodity plays are generally more muted, especially for those dealing in industrial metals, as industrial demand/output typically slows in an economic contraction. Certain agricultural commodities like rubber and cotton may also be adversely affected should people cut discretionary spending.

Economic down-cycle influence growing. And the odds of the global economy slipping into a "down cycle" are growing, evident by the renewed weakness in the US economy; ongoing uncertainties over the sovereign debt issues in The EU. Singapore, with its open economy, posted a surprise 2.8% YoY drop in NODX (non-oil domestic exports) in Jul, which was also the biggest fall since Oct 2009. This further damping the already sullen picture. In instances like this, investors tend to avoid the high-beta cyclical stocks such as properties and commodities and switch into safer defensive ones like utilities and consumer staples.

Downgrade to NEUTRAL. For the reasons mentioned above, we deem it necessary to downgrade our sector weighting to NEUTRAL. Having said that, we are still positive on GAR, making it our top sector pick, given its robust showing in 2Q11 and potentially more earnings surprise in 2H11. While we think that WIL has also put in a credible performance in 2Q11, the still-high inflation in China could continue to suppress margins for its huge operations there; hence we remain more neutral on the stock.