We are downgrading First Resources from Neutral to Underperform, based on our expectations of weak CPO prices going forward. However, we are raising our target price from S$0.18 to S$0.26 because the company is a beneficiary of the weakening rupiah. Coverage of First Resources is transferred to Sunaina Dhanuka.

We expect CPO prices to remain weak in 2009: Our CPO price assumptions are US$400/t for 2009, US$450/t for 2010 and US$550/t for the long term. We believe that recent strength in the CPO price reflects market optimism from strong December exports out of Malaysia. However, we expect exports to return to more-normalised levels in coming months as the seasonal demand wanes. In addition, we expect CPO inventories to rise and to pressure CPO prices when full production resumes in 2Q09.

Earnings hit from falling CPO prices: Based on our expectations of weak CPO prices in 2009, we think that First Resources’ earnings are set to decline by a steep 50% YoY for FY09. However, we note that the company’s earnings are very sensitive to changes in CPO prices – every 1% change in the CPO price from our base price assumption changes the company’s earnings by 2.3%.

Weaker rupiah helps cushion some of the impact from weak prices: We have assumed a weaker rupiah to the US dollar (weaker by 10% for FY09 and by 8% for FY10), reflecting our house view on potential weakness in the rupiah since our earnings update last October. The rupiah depreciation helps to cushion some of the negative effect from weaker CPO prices, given that revenues are US$ driven while costs are mostly in rupiah. Every 1% change in the Rp/US$ exchange rate changes First Resources’ earnings by 2.5%.

We have raised our earnings estimates by 70% for FY09 and by 117% for FY10, on the assumption of improved margins from the refining business that is scheduled to come online in 2009 and due to the weakening rupiah.

12-month price target: S$0.26 based on a PER methodology. Catalyst: Build-up of Malaysian CPO inventories from March onwards.

We downgrade our recommendation from Neutral to Underperform. First Resources is in a good position to deal with the current cyclical downturn due to its low-cost base and relatively strong balance sheet. However, we believe that it will continue to trade at a discount to Astra Agro Lestari (AALI IJ, UP, TP: Rp7,800) which we value at 8x CY09E, due to its small-cap status.