Plantation - “Earnings cliff” threat strengthening

Malaysia’s CPO inventory level for Nov-12 reached another record high of 2.56m mt and coming in higher than consensus estimates of 2.54m mt and our’s of 2.49m mt. Exports have been weaker than expected at 1.66m mt (down 6% MoM) against our expectation of a 5% MoM growth. While we have been right on the better demand from China due to stock-up activities ahead of a regulatory change in early 2013 for edible oil imports, demand from India and Europe were disappointing possibly due to better local vegetable oil production. Looking forward, we believe that the stock level could have peaked in Nov but it should stay persistently high at 2.51m mt in Dec-12. On the overall, we view the latest inventory data negatively as high stocks should keep CPO prices at distressed level of below RM2500/mt for an extended period well into 2013. We reiterate an UNDERWEIGHT rating on the plantation sector given higher possibility of 4QCY12 earnings “falling off the cliff” as we expect extremely low average CPO prices of RM2250/mt (-25% YoY and -21% QoQ) in the quarter. Meanwhile, we are maintaining our CY12-CY13 average CPO price forecasts of RM2,900/mt-RM2,850/mt. Our MARKET PERFORM calls are unchanged on SIME (TP: RM9.00), PPB (TP: RM14.38), FGVH (TP: RM4.40), TSH (TP: RM2.22) and UMCCA (TP: RM7.00). We maintain UNDERPERFORM calls on IOICORP (TP: RM4.40), KLK (TP:RM20.00), GENP (TP: RM8.30), IJMP (TP: RM2.70) and TAANN (TP: RM2.90) due mainly to the low CPO price outlook above.

Another record high inventory due to weak exports. MPOB’s Nov-12 inventory level increased 2% MoM to 2.56m mt and this was higher than the consensus estimate of 2.54m mt and our estimate of 2.49m mt. Exports have been weaker than expected at 1.66m mt (down 6% MoM), against our expectation of a 5% MoM growth. While we have been right on the better demand from China due to stock-up activities ahead of a regulatory change in early 2013 for edible oil imports, demand from India and Europe were disappointing though, possibly due to better local vegetable oil production. Despite low CPO prices throughout November at an average RM2214 (-1% MoM) or a discount of US$348/mt against soybean oil, demands remained surprisingly weak. This is extremely worrying as this suggests that CPO prices may stay below RM2500 when 2013 starts and possibly leading to more earnings downgrades.

Stock level may have peaked in Nov but to stay persistently high above 2.5m mt in Dec-12. Based on our seasonal trend analysis, we see Dec production declining 12% MoM while exports should decline at a less severe rate of 3% MoM. CPO demand should remain resilient in price-sensitive countries such as India and Pakistan. However, some exports declines are still expected as the northern hemisphere is entering its winter season soon where palm oil will be used less (despite its cheaper price) as it tends to solidify in a cold weather. While we do believe CPO prices should appreciate from current extremely low level at below RM2100/mt, the upside should still be limited at below RM2500/mt.

A strong El Niño is unlikely in the near term because the Southern Oscillation Index (SOI) is currently at a neutral level. The latest SOI reading of a positive 4.2 (as of 2 Dec) is still at a neutral level. Recall that SOI readings ranging from negative 8 to +8 indicates neutral ENSO levels (no El Nino or La Nina). According to the Australian Bureau Of Meteorology, climate models indicate that a neutral ENSO situation is likely to remain throughout the southern hemisphere summer (end-Dec to end Mar-13). We hence think that the chance for an El Nino return is diminishing, leading to little excitement for CPO prices.

Reiterate UNDERWEIGHT as planters earnings are poised to fall off the cliff in 4QCY12. The low CPO prices of RM2224/mt in 4QCY12 so far reaffirm our view that planter earnings are poised to dive at least 30% YoY and 20% QoQ. This is in line with the industry 4QCY12 average CPO prices, which we believe should have tumbled to ~RM2250/mt (-25% YoY and -21% QoQ). We believe pure planters’ 4QCY12 earnings will likely fall by at least the same magnitude as CPO prices tend to have a very significant impact to their earnings historically. However, conglomerates with earnings support from their other divisions such as SIME and PPB should be less affected.

Source: Kenanga