Plantation - When record high inventory becomes a norm…

Malaysia’s CPO inventory level for Dec-12 reached another record high of 2.63m mt, coming in higher than the consensus estimate of 2.53m mt and our estimate of 2.51m mt. Sabah’s production turned out to be stronger than expected and caused the production to decline only 6% MoM  against our expectation of an 8% drop. Meanwhile, exports remained weak due to the decline in exports to China (-30% MoM to 349k mt) and Europe (-19% MoM to 160k mt). Looking forward, we believe that the stock level could reach another record high in Jan-13 to 2.66m mt. Although we are expecting Jan’s production to decline 11% MoM to 1.58m mt due to seasonal factors, exports are expected to drop by a similar rate of 10% MoM to 1.48m mt. On the overall, we view the latest inventory data negatively as high stocks  should  keep  CPO  prices  at  distressed  levels  of  below  RM2500/mt  for  an extended period. We reiterate our UNDERWEIGHT rating on the plantation sector given our strong conviction that 4QCY12 earnings will “fall off the cliff” due to the extremely low average CPO price traded of RM2170/mt (-27% YoY and -24% QoQ) in the quarter. Meanwhile, we are maintaining our CY12-CY13 average CPO price forecasts of RM2,900/mt-RM2,850/mt but may revise it down further if the inventory level stays above 2.0m mt for another two months. 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 to the low CPO price outlook. Our MARKET PERFORM calls are unchanged on SIME (TP: RM9.00), FGVH (TP: RM4.40), TSH (TP: RM2.22) and UMCCA (TP: RM7.00). Our only OUTPERFORM is PPB (TP: RM14.38) as we expect it to benefit from Wilmar’s earnings recovery due to the turnaround in its soybean crushing margin and a better palm oil  downstream margin.

Another record high inventory due to the strong CPO production.  MPOB’s Dec-12 inventory level rose 2% MoM to 2.63m mt and this was higher than the consensus estimate of 2.53m mt and our estimate of 2.51m mt. Sabah’s production turned out to be stronger than expected and caused production to decline only 6% MoM against our expectation of a 8% drop. Meanwhile, exports remained weak due to decline in exports to China (-30% MoM to 349k mt) and Europe (-19% MoM to 160k mt). Despite low CPO prices throughout December at an average RM2052/mt (-7% MoM) or at discount of more than US$350/mt against soybean oil, the demand remained weak. This is extremely worrying as it suggests that CPO prices may stay at the current depressed level of below RM2500 for an extended period.

Stocks to continue going higher in Jan-13?  We believe stocks level can still inch up higher by 1% to 2.66m mt by end Jan-2013 based on our preliminary estimate. Although we do expect Jan’s production to decline 11% MoM to 1.58m mt due to seasonal factors, exports are expected to drop by a similar rate at 10% MoM to 1.48m mt. Palm oil demand from China may remain weak in the short term in view of the record-high  stocks. In addition, winter in the northern hemisphere peaks in Jan this will cause palm oil usage to remain low. On the overall, the record-high inventory should keep CPO prices staying at current depressed levels of below RM2500/mt for an extended period.

A strong El Niño is unlikely in the near term. This is because the Southern Oscillation Index (SOI) is currently at a neutral level. The latest 30-day SOI reading of negative 6.7 (as at 1 Jan) is still at a neutral level. Note that SOI readings ranging from negative 8 to plus 8 indicate a neutral ENSO level (no El Nino or La Nina). Hence, we think that the chance of an El Nino return is diminishing, which means there will be little excitement for CPO prices. 

Reiterate UNDERWEIGHT, strong conviction that earnings will “fall off the cliff” in 4QCY12. We reiterate our view that planters’ earnings are poised to dive at least 30% YoY and 20% QoQ in line with the 4QCY12 average CPO price trend, which has tumbled by 27% YoY and 24% QoQ. The earnings are likely to fall by at least the  same magnitude as CPO prices have a very significant impact to planters’ earnings historically. Since we believe that this has yet to be reflected in the consensus earnings forecast, another round of deeper earnings cut is likely. Hence, we strongly believe that investors should cut their positions in plantation stocks ahead of a significant consensus downgrade post the Feb earnings season.

Source: Kenanga