Plantation - Dismal year ahead

We expect the general news flows for the Plantation sector in 1QCY13 to be likely discouraging. Although the inventory level could have peaked at 2.56m mt in Nov-12, we expect it to stay high at above 2.0m mt throughout 1QCY13 and hence limiting the CPO price upside. In the next earnings season in Feb-13, 4QCY12 earnings may “fall off the cliff” as we expect it to drop at least 30% YoY and 20% QoQ. This is in line with the expected extremely low average CPO price of RM2250/mt in 4QCY12, representing a 25% drop YoY and 21% decline QoQ. Lastly, we believe more consensus earnings downgrade for 2013 will happen as 1Q13 CPO demand may slow down due to tighter regulation from China on edible oil from 1-Jan-2013 onwards. We are maintaining our CY13 average CPO price forecast of RM2,850/mt and reiterating our UNDERWEIGHT call on the plantation sector based on reasons stated above. Note that our CY13 average CPO price forecast is below the consensus estimate of RM2950/mt. We believe the risk for a consensus earnings downgrade is getting higher as CPO price will likely start off 2013 at below RM2500/mt. Maintain our 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), PPB (TP: RM14.38),  FGVH (TP: RM4.40), TSH (TP: RM2.22) and UMCCA (TP: RM7.00).

Malaysia palm oil inventory may stay high at 2.51m mt in Dec-12; to stay high at above 2.0m mt throughout 1Q13. Although we believe stocks level should have peaked in Nov-12 at 2.56m mt, we only expect it to decline slightly by 2.0% to 2.51m mt in Dec-12. We believe the exports downtrend may continue with a 3% MoM drop in Dec-12 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 cold weather. Hence, despite the expected Dec production decline of 12% MoM, the inventory should stay persistently high at above 2.5m mt.  Looking ahead to 1Q13, we expect the inventory to decline only marginally and to stay above 2.0m mt and limit the CPO price upside to below RM3000/mt.

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

Expect consensus to downgrade 2013 earnings further as CPO spot price should start the new year at depressed level of below RM2200/mt. While Malaysia government effort to introduce the new CPO export tax regime (effective  1-Jan-2013) should bode well for CPO price in the long term, tighter regulation from China on edible oil from 1-Jan-2013 onwards may limit demand in 1Q13. As China palm oil trader may have stock up significantly ahead of the regulation change, demand may slow down in 1Q13 for them to clear the inventory. Hence, CPO price upside may be capped for an extended period.

Latest USDA forecast of a higher soybean oil inventory should limit CPO price upside.  In its Dec-12 issue of World Agricultural Supply and Demand Estimates (WASDE) report, USDA has increased its 2012/2013 global soybean oil inventory forecast by 3% to 3.00m mt. We gather that the soybean oil production estimate has been raised by 0.3% to 43.18m mt due to the increased soybean crushing and better oil extraction rate. As palm oil is commonly used as a substitute for soybean oil for food and industry usage, a better prospect for soybean oil production will curb palm oil prices. Historically, the correlation between CPO and soybean oil prices is almost perfect at 98%.

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 SOI reading of a positive 4.2 (as of 2 Dec) is still at a neutral level. Hence, we think that the chance for an El Nino return is diminishing. This means little excitement for CPO prices ahead.  

Source: Kenanga