Plantation Sector - Bottoming soon? Overweight

- Why were CPO prices falling? In spite of quantitative easing measures announced by the U.S., CPO futures have been sliding on the back of concerns that palm oil inventory in Malaysia would hit three million tonnes by 1 January 2013 while inventories in Indonesia are expected to be 3.5 to four million tonnes. An industry expert implied that Malaysian palm oil exports are unexciting. 

A few plantation companies in Malaysia are of the view that CPO prices have been weak due to market perception that palm oil supply is ample. Channel checks have also indicated that Indonesian CPO producers are not dumping CPO in the physical or futures market.

We understand that nobody knows the exact size of palm oil inventory in Indonesia due to the uncertain amount of domestic consumption in the country. It is estimated that domestic consumption of palm oil in Indonesia could be seven to ten million tonnes/year. Going forward, we reckon that domestic demand for palm oil in the country would improve due to the increase in refining capacity.       

- Is demand weak? Demand for Malaysian palm oil has eased but so has production. Palm oil exports from Malaysia shrank 3.6% YoY in January to August 2012. In comparison, palm oil production in Malaysia fell 7% YoY during the same period.  Demand for palm oil from China fell 19.1% YoY in the eight months of the year. However, this was partly cushioned by stronger imports by Netherlands and India. 

Palm oil exports from Malaysia have recovered in September. According to SGS, China bought 39.1% more palm oil in the 20 days of September compared to the same period in August. Independent cargo surveyors indicated that Malaysian palm oil exports climbed 12.8% to 14.6% in the 20 days of September versus the same period in August. 

- Tax-free CPO export quota to have positive effect? The additional tax-free CPO export quota of two million tonnes is supposed to be used by year-end. We do not know if unused export quota can be carried forward to 2013F. Since the quota was only announced at end-July 2012, this implies that there should be additional exports of 400,000 tonnes per month from August to December 2012. The quantum of 400,000 tonnes of palm oil is close to one-third of Malaysia’s monthly palm oil exports. As such, we reckon that the possibility of palm oil inventory in Malaysia hitting three million tonnes by year-end may be unlikely.  The highest level of palm oil inventory ever recorded in the past five years was 2.27mil tonnes in November 2008.    

- What about concerns over higher soybean production in South America? According to the latest report by the USDA (US Department of Agriculture), soybean production in Brazil and Argentina are expected to increase 26.5% to 136mil tonnes in 2012/2013F.  However, USDA has also projected that global ending inventory of soybean would be flat at 53.1mil tonnes in 2012/2013F as lower stockpiles in U.S help offset higher numbers from South America. Ending inventory of soybean in U.S is forecast to shrink 11.8% to 3.13mil tonnes in 2012/2013F underpinned by a 13.8% fall in production. 

- CPO prices close to bottoming? According to industry experts at the recent palm oil conference in India, CPO prices would bottom at RM2,600/tonne. As three-month CPO prices were hovering between RM2,600/tonne to RM2,700/tonne yesterday, this would imply that CPO prices are close to the bottom. Spot CPO price closed at RM2,512/tonne yesterday while three-month CPO price closed at RM2,646/tonne. 

- Average CPO price assumption revised downwards to RM3,100/tonne for 2012F. This is due to the recent fall in CPO futures prices. Our CPO price assumption of RM3,100/tonne for 2012F implies that CPO price would average about RM3,000/tonne in 2H2012. In 1H2012, average CPO price was RM3,199/tonne. Year-to-date, CPO prices have averaged about RM3,144/tonne. For 2013F, we have assumed that average CPO price would improve to RM3,200/tonne.    

- Maintain positive. In spite of the downward revision in our CPO price assumption, we are maintaining our positive stance on the plantation sector. We believe that the recent slide in the share prices of plantation companies presents an opportunity to buy. We reckon that any negative newsflow on palm oil has already been discounted by the market and reflected in the 2% to 16% decline in plantation stocks since August 2012. 

Price discount between CPO and soybean oil at 2008’s crisis levels. In contrast to share prices, CPO prices have eased by a sharper 17% in the past two months. The price discount between CPO and soybean oil is now at 2008’s crisis levels of more than 20%. Presently, the price discount between the two commodities is 28.7% or US$341/tonne versus the average of 26.1% in 2008 and five-year average of 16.4%. The price discount was the highest at 40.8% in November 2008.

Source: AmeSecurities