Plantation - OVERWEIGHT - 26 June 2012

Maintain OVERWEIGHT on the Plantation sector. We believe that the current CPO prices of ~RM2,850* is bottoming out. It is now only 5% away from its 2011 bottom of ~RM2,700 per mt and is already 28% below the 2011 high of ~RM3,950 per mt. We continue to like the sector for the resilient CPO demand globally (especially in Asia), a smaller CPO output due to tree stress, signs of further monetary easing from the major economies and higher chances for an El Nino to occur in 2H12. With expected demand growth of 6.6% YoY surpassing the 4.8% YoY growth in production, the CPO stock-to-usage ratio should decline further to 15.63% (a 124ppts decline from 16.87% last year). Maintain our CY12E average CPO price of RM3,200/mt with an upside bias pending the confirmation of El Nino. Reiterate OUTPERFORM calls on SIME (TP: RM10.80), GENP (TP: RM9.90) and IJMPLNT (TP: RM4.00) on valuation grounds. To leverage on their double-digit FFB growths, we also have OUTPERFORM calls on TSH (TP:  RM2.50), UMCCA (TP: RM8.00) and TAANN (TP: RM5.08). MARKET PERFORM calls are maintained for KLK (TP: RM22.10) and IOICORP (TP: RM5.35).

CPO prices already close to a bottom. The current CPO prices level of ~RM2,850 per mt is only 5% away from its 2011 bottom of ~RM2,700 per mt and is already 28% below the 2011 high of ~RM3,950 per mt. Although CPO prices did fall to RM1,500 per mt during 2008 crisis, we do not think such event will materialize as major economies has been prepared to act swiftly when there is any sign of economy slowdown. With higher chances of monetary easing globally and possibility of El Nino materializing, we expect better outlook for CPO prices.

Demand side still resilient. Based on Oil World data, global CPO demand is expected to register a healthy growth of 6.6% YoY to 51.43m mt  in the 2011/12 season. Despite the recession in Europe, Asia’s consumption of palm oil remained stable as it is mainly used for food consumption. Within Asia, Indonesia’s CPO usage is expected to register the strongest consumption growth (+14.1% YoY to 7.06m mt) followed by China (+9.8% YoY to 6.64m mt) and India (+6.1% YoY to 7.16m mt). YTD, MPOB data showed that that the total exports from Jan12-May12 had grown 5% YoY to 6.67m mt. Going forward, the upside potential for CPO prices remains bright as most of Asia’s consumption of cooking oil on a per capita basis is still behind the global’s average consumption.

Supply side affected by tree stress. Although CPO production grew 9% MoM to 1.38m mt in May 12, tree stress effects had actually intensified as the number actually slumped 21% YoY, worse than the 17% YoY drop in Apr-12. We believe there is still long way to go before the tree stress effect ends. In the past 10 years, the worst CPO production down-cycle due to tree stress lasted for more than two years. The current tree stress is only 3 months old and hence it will be some time before one can see a significant increase in YoY production again. China’s reduction of its interest rate positive on  CPO prices.  In early Jun, China reduced its interest rate by 25bp to 6.31%, following Australia’s earlier cut of 25bp to 3.50%. As this is the country’s first interest rate cut since Sep 2008, it may indicate that China has shifted its policy towards monetary easing to sustain its economic growth. We believe the United States may also introduce further easing policies as its 1Q12 GDP growth remained low at 1.9% (below the long term growth of 2.0%) while inflation fell to 1.7% in May-12 (below its 10-year average of 2.4%). Generally, CPO prices will benefit from this as an easing policy will usually result in a better economy growth going forward and hence a higher CPO demand.

CPO prices should surge if El Nino returns in 2H12. According to Australia Bureau of Meteorology, all seven models surveyed indicate that conditions are likely to approach or possibly exceed the El Nino thresholds during Aug-12 to Oct-12. In addition, US Climate Prediction Center mentioned that there is a 50% chance that El Niño conditions will develop during 2H12. We now see higher chances for El Nino  to return as the 30-day Southern Oscillation Index (SOI) values have remained on the negative side of neutral over the past two weeks. We expect CPO prices to surge if El Nino is confirmed as FFB production may fall by a staggering 30% depending on the severity of the El Nino.

Source: Kenanga