Investment Highlights

• Big importers working towards reducing dependency. In this report, we look at China and India’s efforts to reduce import dependency on vegetable oils. We believe that even if the two countries succeed in the long term, they would still need to import grains and vegetable oils. Hence, there would be a floor level of demand from the two countries even though imports may no longer be at record levels. We reckon that it is impossible to reduce import dependency to zero.
  
  Also, in spite of efforts to boost domestic production of vegetable oils in China and India, these would not be enough to fulfil the edible oil requirements of the countries’ population. According to Worldometer (elaboration of data by the United Nations), China’s population is estimated to inch up by 1.4% to 1.46bil in 2030F from 1.44bil currently while India’s population is forecast to grow by 8.7% to 1.5bil in 2030F from 1.38bil presently. China’s population is expected to peak in 2030F and decline thereafter.
  
  Based on a market share of 15% (2019: 18%) for palm oil on China’s consumption of oils at 40.5mil tonnes (2019: 39.3mil tonnes), we estimate the floor level of palm demand for China to be 6.1mil tonnes (2019: 7.06mil tonnes). Based on a market share of 30% (usual levels are 35% to 40%) for palm oil on edible oil consumption of 25mil tonnes, we estimate the floor level of demand for India to be 7.5mil tonnes (2019: 9mil tonnes). India imports about 60% of its edible oil requirements yearly.
   
• China is self-sufficient in rice and wheat. Currently, China imports about 10% of its grain requirements. China is selfsufficient in several types of grains i.e. rice and wheat. The country’s main imports are corn, dairy products and soybean. China imported about 88.0mil tonnes of soybean in 2018 and 88.5mil tonnes in 2019. Corn and soybean are used largely in the feed meal industry while the by-product, soybean oil, is blended with other vegetable oils to produce cooking oil.
   
• Planting more soybean. China released its first white paper on grains in 1996. In October 2019, China issued a white paper on food security. Since 2012/2013, the country’s soybean production has climbed by 36.0% to 17.0mil tonnes in 2019/2020E. According to the USDA, soybean planted areas in China are forecast to be 9.46mil ha in 2020E/2021F vs. 8.4mil ha in 2018/2019. About 3.6mil ha were planted with soybean at Heilongjiang in 2018 vs. about 2.4mil in 2013. China’s main soybean areas are the Heilongjiang, Inner Mongolia and Jilin provinces. China’s soybean output of 17.0mil tonnes are about 19.2% of the country’s soybean imports of 88.5mil tonnes in 2019.
   
• China ramping up planting of oil palm. We think that China is moving towards reducing dependency on imported oil palm, although in baby steps. First, we reckon that Chinese companies may be looking to acquire oil palm plantations in Indonesia. Currently, Tianjin Julong Group owns a 60,000ha oil palm plantation in West Kalimantan, which was acquired from a local company in 2014.
  
  We would not be surprised if Tianjin acquires more land in Indonesia if the pricing and conditions are right. Tianjin Julong is one of the largest companies in the vegetable oil processing sector in China. Secondly, in 2019, it was reported that the Chinese Academy of Tropical Agricultural Sciences has selected the first palm tree species for mass production in China. The academy has plans to expand the cultivation of oil palm in Yunnan and Guangdong.
   
• India to plant more oil palm. To boost the income of the local farmers and reduce reliance on palm imports, India plans to increase plantings of oil palm in the country.
  
  It was reported in the press that India may raise import taxes on vegetable oils to raise funds to boost domestic production of oil palm. Presently, India has more than 300,000ha of oil palm plantations. We believe that the country’s CPO production was less than one million tonnes in 2019. India’s consumption of vegetable oils amounts to about 25mil tonnes per year. Out of these, about 60% to 70% are imported. India imports more than 90% of its palm oil requirements annually. In 2018/2019, India imported about 9.4mil tonnes of palm products and 5.5mil tonnes of soft oils such as sunflower oil and soybean oil.
   
• Implications for the sector. We believe that palm demand from China and India would soften in the long term if both countries are successful in achieving their self-sufficiency goals. Nevertheless, we draw comfort from the fact that it would take a long time for India to ramp up plantings of oil palm and for China to deepen its penetration into the palm oil sector directly. India and China accounted for 37.4% of Malaysia’s palm exports in 2019 and 34.7% of Indonesia’s palm exports in 2018.
   
• Seeking new markets. In the long term, we believe that new markets such as Africa, Turkey and the Middle East may help replace any fall in palm demand from the traditional buyers such as China, India and the EU. Africa has a population of more than 1.2bil. According to a UN report in 2016, the active working age population in Africa grew from 33% of total population in 1980 to 36.2% in 2015. Malaysia’s palm exports to Africa surged to 2.1mil tonnes or 11.5% of total exports in 2019 from 1.4mil tonnes in 2010.
   
• Biodiesel is another source of demand. Domestic consumption of palm oil as biodiesel in Malaysia and Indonesia would also help alleviate any weakness in external demand and reduce dependence on the traditional export markets. Indonesia plans to use B40 in the transportation sector in 2022F and B100 in the long term. B40 could absorb about 12.4mil tonnes or 14.2mil KL (kiloliters) of palm oil from the system annually. Indonesia is currently carrying out tests on B40. B30 is estimated to absorb about 8.0mil KL or 7.0mil tonnes of palm oil in 2020E.
  
  Short-term replenishing to boost palm demand. In the short term, we think that both countries would still need palm oil. Hence, China and India would be restocking or replenishing palm inventories if stockpiles are too low. We believe that China would also be buying more vegetable oils for its state reserves while India would be stocking up if there’s poor harvest of vegetable oils due to unfavourable weather conditions.
  
  We expect India’s palm demand to recover in 2021F after falling in 2020E due to Covid-19. India’s palm imports may revert to the normal levels of 8mil to 9mil tonnes in 2021F after 7mil tonnes estimated for 2020E (2019: 9.3mil tonnes). However, we think that China’s palm demand may soften in 2021F as the country switches back to soybeans.
   
• Palm-based cooking oil is still a food staple. In conclusion, we believe that palm oil would continue to be a staple cooking oil product in the long term. Palm oil’s advantages over the other vegetable oils are its price competitiveness, stability as a frying oil and high oil production yields. However, palm producers have to find new markets for palm oil if long-term demand from the traditional buyers such as China, India and the EU eases.
   
• NEUTRAL stance. We maintain NEUTRAL on the plantation sector in 2H2020. We believe that in 2H2020, CPO price would be capped by rising palm production. We are assuming average CPO prices of RM2,300/tonne for 2020E and RM2,400/tonne in 2021E. We have a BUY on TSH Resources for its young oil palm trees and de-gearing exercise, which will reduce its net gearing ratio to 50% from 83%. Average age of the group’s oil palm trees is 10 years old. We have a fair value of RM1.21/share for TSH. We downgrade TH Plantations (THP) to SELL due to a high net gearing of 214.7% (as at end-FY19). The group’s share price has also exceeded our fair value of RM0.33/share.

Source: AmInvest Research - 14 Sept 2020