Thursday 3 January 2013

2013 STRATEGY – PLANTATION (NEUTRAL)


Weaker  average  CPO  price  in  2013.  We  expect  CPO  price  to  average  RM2,800  based  on West Malaysia price versus an estimated RM2,870 this year. Although weaker on a y-o-y basis, it  represents  a  significant  recovery  from  currently  depressed  levels,  and  will  be  dependent  on the following: 
1. Reduction in Malaysia’s CPO  export  duty,  thus  freeing  up  the  outflow  of  CPO  from  the country. At the current price, CPO export duty will go down to zero come January 2013;
2. Nationwide rollout of biodiesel in Malaysia to use up 0.5m tonnes of CPO;
3.  Surge  in  new  refining  capacity  in  Indonesia  will  reduce  the  bargaining  power  of  Indonesian refiners  versus  CPO  producers,  while  the  erosion  of  downstream  margin  will  discourage  the dumping of prices in the export market, thus resulting in the operating environment normalising in 2013; and
4. Seasonal production downcycle, which should pare down Malaysia’s inventory by 0.4 to 0.9m
tonnes by mid-2013.

Another  year  of  healthy  production. Given the friendly weather in the past 24 months, 2013 production will continue to be healthy. Indonesia should register another year of robust growth, amounting  to  some  1.6m  tonnes,  compared  with  an  estimated  1.8m-tonne  increase  in  2012. Malaysia  will  also  chalk  up  higher  production  growth  although  the  quantum  will  be  rather marginal.  The  question  really  is  whether  global  demand  can  absorb  Indonesia’s  rising production.  Should  global  demand  continue  to  grow  at  the  normal  5m  to  6m-tonne  rate,  the increase in Indonesia’s production would easily be absorbed. Otherwise, the strong supply will continue to weigh down on CPO prices.

Trade  may  normalise  in  2013.  Indonesia’s will  be  seeing  a  significant  increase  in  annual refining capacity throughout 2013 to about 40m tonnes by early 2014. Currently, due to the lack of refining capacity in Indonesia, Indonesian refiners have been able to buy CPO at a discount to the international market price. Given their lower raw material cost relative to their Malaysian counterparts,  Indonesian  refiners  are  able  to  sell  at  more  competitive  prices.  This  had  directly given  risen  to  an  inventory  build-up  in  Malaysia  throughout  2012.  As  more  refining  capacity comes on stream in Indonesia, the discount at which Indonesian refiners buy CPO will narrow, thus  affecting  their  ability to sell cheaply. This along with Malaysia’s lower CPO export duty come January 2013, will help to remove trade distortions and facilitate the free flow of CPO. As such, inventory should normalise from the current record levels and Malaysian refineries should see some improvement in margin although we have not factored this into our forecasts.

Weather concerns  linger  but  nothing serious,  as  soybean  production  is  still  on  track  tomeet demand. On the soybean front, while there continues to be worries over potential delays in  planting  in  Argentina  due  to  heavy  rainfall  and  some  dry spots in Brazil’s soybean planting areas,  any  impact  arising  from  the  patchy  weather  would  only  be  known  later,  ie  when  the planting period comes to a close and harvesting begins sometime in 1Q2013. According to Oil World, South America’s soybean production needs to increase by 28m to 30m tonnes in 2013 in order  to  ensure  a  sufficient  supply  of  global  oilseeds  until  the  North  American  crop  arrives  in 3Q2013.  At  this  point  of  time,  we  believe  this  is  still  achievable  despite  the  potential  weather impact. Recently, Argentina’s “Sociedad Rural” (the Rural Society of Argentina), projected that 3m-4m ha of Argentina’s crop areas will be unplanted this year, and that the country’s soybean crop would only reach some 50m tonnes in 2013 (+23.5% yoy from 40.5m tonnes in 2012). This is still an increase of 9.5m tonnes. Recently, Brazil’s “CONAB” (the Agriculture Ministry’s crop-forecasting  agency),  raised  its  soybean  crop  estimate  for  2013 by  4.7%  to  a  record  82.6m tonnes  (+30.3%  y-o-y  from  63.4m  tonnes  in  2012),  due  to  more  soybean  planting  at  the expense  of  cotton  and  grain.  This  implies  an  increase  of  19.2m  tonnes.  It  also  means  that Argentina and Brazil alone would already  be producing an additional 28.7m tonnes of soybean in 2013, which according to Oil World estimates, is enough to meet demand. This does not even include the soybean crop coming from other South American countries like Paraguay, Uruguay etc, which are projected to produce an additional 5m tonnes of soybean in 2013.

Discount  to  soybean  oil  remains  high.  Palm  oil  price  is  trading  at  more  than  USD400 discount to that of soybean oil. The key factor to this is the ample supply of palm oil relative to soybean oil. Malaysia’s palm oil stock to usage ratio is on the high side at 11.1% based on November  data.  Should  the  stock  usage  ratio  remain  at  these  levels,  the  steep  discount  to soybean  oil  will  remain  relatively  high,  unless  the  current  South  American  soybean  planting turns in a bumper harvest. We note that soybean supply tightness is perhaps behind us now as the  South  American  season  should  turn  out  to  be  significantly  better  than  the  2012  North American  season,  during  which  the  region  was  hit  by  a  worst-in-a-generation  drought.  That said, we note that the speculative net long positions for soybean have also fallen by more than 50% off its peak, indicating that the better South American harvest is already priced in.

Possible  changes  in  EU  biofuel  policy  could  curb  demand.  Demand  could  be  affected  by possible changes in biofuel and trade policies in the EU. Recent media reports suggest that the EU is considering limiting the use of crop-based biofuel to 5% by 2020. The EU’s original biofuel target was 10% by 2020, with the bulk of it supposed to  have come from crop-based biodiesel made  from  rapeseed  and  wheat.  Currently,  as  4.5%  of  biofuel  in  the  EU  already  comes  from vegetable oils, this means that there would not be much more room for  an increase in demand in the future. There are also reports that the EU is considering imposing anti-dumping duties on Indonesian and Argentine biofuel, as it is currently being sold for USD60-USD110/tonne lower than  EU biodiesel,  which  has led  to  several  bankruptcies  Europe’s biodiesel industry.  If  this is implemented,  Indonesia’s  biofuel  demand  may  also  be  affected,  which  will  in  turn  curtail demand for CPO.

… thus, Malaysia’s biodiesel demand needs  to  absorb  supply  surplus.  With  these  risks emerging on the biofuel front, it is now crucial for the palm oil producing countries to have their own biodiesel mandate to absorb the surplus supply. Malaysia is rolling out its B5 biodiesel on nationwide  basis,  which  will  use  up  0.5m  tonnes  of  CPO  per  annum.  Biodiesel  was  partly responsible for Indonesia’s surge in palm oil consumption from 3.9m tonnes to 6.7m tonnes over the past five years; hence its effectiveness should not be underestimated.  Meanwhile, the significant  jump  in Malaysia’s monthly  local  consumption  to  more  than  200k  tonnes  for  two consecutive months suggests that conversion to biodiesel has started ahead of the nationwide B5 blend. The discount at which CPO is trading relative to crude oil also reinforces the case for biodiesel.

CPO  price  decline  largely  done.  We  believe the decline  in  CPO  prices has  largely  reflected the  rise  in  inventory,  while  the  parity  with  crude  oil  will  lend  support  to  palm  oil  price.  Going forward,  we  see  Malaysia’s nationwide  B5  biodiesel  rollout  and  the  substantially  lower  CPO export  duty  as  catalysts  that  could  potentially  help  to  bring  down  inventory  levels,  and  in  turn boost  CPO  prices.  Our  CPO  price  assumption  of  RM2,800  implies  that  palm  oil  price  could surge to as high as RM3,000 – RM3,100 in 1H13, before settling below the RM3,000 level later.

But  look  out  for  another  quarter  of  poor  earnings.  As  CPO  price  only  started  on  a  steep decline  in  September  2012,  the  Sept  quarter  results  did  not  reflect  the  full  impact  of  the  price decline. Instead, this weakness will show up in the upcoming December quarter results due to be announced in February 2013, whereby the 23% drop in average CPO price will be reflected. Investors looking to buy plantation stocks may best wait for the kneejerk reaction anticipated to follow when the December quarter results are released.

El Nino could come back. The Southern Oscillation Index (SOI) has recovered to neutral zone after  briefly  plunging  into  deep  negative  territory,  rendering  the  El  Nino  signal  a  fake  one. Nevertheless, we note that the SOI has been staying very close to the zero line and could swing back  to  El  Nino  zone.  By  next  year,  it  will  be  15  years  since  the  last  severe  El  Nino  hit  this region; hence investors should keep an eye on this potentially price-boosting event.

Neutral on Malaysian plantations. Overall, we are Neutral on the Malaysian plantation sector. Although  CPO price is  poised  for  some  recovery  in  2013,  valuations are largely  uncompelling; hence  our  Neutral  stance.  We  accord  target  PEs  of  15x-16x  CY13  to  the  big  cap  plantation stocks  and  12x-13x  CY13  for  the  mid-cap  stocks  under  our  coverage.  Our  large  cap  top  pick remains  Sime  Darby,  an  integrated  player  with  stable  contributions  from  its  non-plantation related  industries,  which  will  provide  an  earnings  buffer  during  a  CPO  price  downturn,  and whose  valuations  are  at  a  2x-3x  PE  discount  to  its  peers.  Among  the  mid-cap  high  growth stocks,  we  like  Sarawak  Oil  Palms  and  TSH  Resources.  We  may  upgrade  our  fair  values  to incorporate  higher  target  PEs  of  20x  –  21x  should  CPO  price  tick  up  and  hang  on  to  those elevated levels, especially coming off a low price base similar to what took place in 2009.
Source: OSK

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