Investment Highlights

• NEUTRAL. We are neutral on the palm oil sector as we believe that there is a balance between the positive and negative factors. Also, we think that at a CPO price of more than RM3,500/tonne, there are more downside risks instead of upside. We reckon that industry palm production would rebound in 2021F after sliding in 2020E. CPO output was weak in Malaysia and Indonesia in 2020E, dragged by the lagged impact of the drought and haze, which took place in 3Q2019. On a positive note, we expect industry palm demand to recover in 2021F after being hit by Covid-19 in 2020E. We have assumed an average CPO price of RM2,500/tonne for Malaysia in 2021F vs. 2020’s average MPOB spot price of RM2,765/tonne.
• The smaller plantation companies under our coverage such as IJM Plantations (IJMP) and TSH Resources are currently trading at FY21F PE of 22.0x to 25.0x while the larger and integrated companies are trading at multiples of 24.0x to 27.0x (excluding Sime Darby Plantation and FGV Holdings). We have a BUY on TSH Resources with a fair value of RM1.25/share. Our fair value is based on FY21F PE of 25x.
• We would turn positive on the plantation sector if industry palm output turns out to be lower than expected. If industry palm production is weaker than estimated, then palm inventory would stay low. Although palm inventory in Malaysia is below two million tonnes currently, there is risk that palm stockpiles would increase on the back of a recovery in production. Average monthly palm inventory in Malaysia was 2.2mil tonnes from 2015 to 2019 and 2.5mil tonnes in 2019. Average palm inventory in Malaysia is estimated to be 1.8mil tonnes in 2020E.

Supply factors

• Industry palm production to increase in 2021F, driven mainly by Indonesia. Oil World has forecast global production of palm oil to increase by 4.0mil to 5.0mil tonnes in 2021F mainly due to Indonesia. Oil World estimates CPO output in Indonesia to improve by 8.2% to 45.4mil tonnes in 2021F from 42.0mil tonnes in 2020E. The Indonesia Palm Oil Association expects the country’s CPO output to rise by 4.3% to 49mil tonnes in 2021F from 47mil tonnes in 2020E. We believe that a recovery in FFB yields and ample rainfall would lead to higher industry palm production in Indonesia in 2021F.
• Malaysia’s CPO production is expected inch up in 2021F... Currently, Oil World forecasts CPO production in Malaysia to rise to 19.5mil tonnes in 2021F from about 19.3mil tonnes in 2020E. We believe that the unexciting CPO output in 2021F is premised on the fact that there is a shortage of foreign labour in Malaysia presently. Also, the impact of a reduction in fertiliser application by smallholders in 2019 may still continue in 2021F
• ... although historically there has always been a robust rebound in CPO output after a year of decline. Since 1990, industry FFB yields and palm production in Malaysia had always increased in the subsequent year after a year of decline. The exception was 2010 when Malaysia’s CPO production fell by 3.3% in 2010 after easing by 1.0% in 2009. The weak CPO output in 2010 was attributed to torrential rains in the beginning of the year, which affected harvesting.
• In most cases, the magnitude of the recovery in palm production in Malaysia in the following year, was double-digit percentage. The exceptions were 2012/2013 and 2018/2019 when the rebound was weak to unfavourable weather conditions. CPO production in Malaysia inched up by only 2.3% in 2013 after edging down by 0.1% in 2012 due to hot and dry weather. CPO output improved by a mere 1.8% in 2019 after easing by 2.1% in 2018 due to the drought and haze in 3Q.
• The strongest output recovery was in 2017. In 2017, Malaysia’s CPO production surged by 15.0% to 2.0mil tonnes after a 13.2% slide in 2016. CPO output jumped by 11.3% in 2011 after falling by 3.3% in 2010. The biggest recovery took place in 1999 when CPO production in Malaysia climbed by 26.9% to 10.6mil tonnes after contracting by 8.3% on El Nino in 1998.
• Global soybean inventory to decline by 10.3% to 85.6mil tonnes in 2020E/2021F. We believe that the tightness in global soybean supply has already been priced in by surging soybean prices. US soybean price climbed by 21.5% to US$11.92/bushel on 27 November 2020 from US$9.81/bushel on 31 December 2019. The fall in global soybean stockpiles in 2020E/2021F is mainly driven by the decline in US inventory. On the back of lower carry-over inventory from the previous season and strong exports to China, US soybean inventory is envisaged to fall by 66.6% to 4.76mil tonnes in 2020E/2021F from 14.3mil tonnes in 2019/2020E.

Demand factors

• On a positive note, we expect industry palm demand to recover in 2021F. We think that India’s imports of palm oil would revert to the normal level of 8.0mil to 9.0mil tonnes per year in 2021F vs. 6.0mil to 6.5mil tonnes in 2020E (2019: 9.3mil tonnes). Covid-19 had reduced India’s palm demand from the HORECA (hotels, restaurants and catering) segment in 2020E. HORECA accounts for about a third of India’s palm usage.
• We believe that China would continue restocking palm oil in 2021F. Hence, China’s palm imports may exceed 2020E’s level of about six million tonnes. In 2019, about 22.2% of palm oil were used in the oleochemical industry in China while another 20.8% were used by instant noodles companies. An additional 20.8% of palm oil were used by the catering industry in China while the balance 57.0% were used in the food processing, solid fats and biodiesel industries.
• China’s demand for commodities has been robust in 2020E after the Covid-19 lockdown in Wuhan. China has been purchasing various soft commodities after the country ended its lockdown in Wuhan on 8 April 2020. Apart from stockpiling for the state reserves, we believe that the ramp-up in purchases was also due to China’s commitment to buy US$36.5bil worth of agricultural products from the US this year. China’s purchases of soybeans rose by 17.9% YoY to 11.16mil tonnes in 1H2020.
• Indonesia biodiesel activities to pick up in 2021F. Indonesia’s biodiesel consumption is currently forecast to be 9.2mil KL (8.0mil tonnes) in 2021F compared with 8.0mil KL (6.97mil tonnes) in 2020E. The recovery in the biodiesel consumption in 2021F is expected to be driven by a pick-up in transportation activities in Indonesia following the ease of movement restrictions. As for B40, Indonesia has delayed implementing the biodiesel policy due to insufficient funds. B40 would have lifted Indonesia’s biodiesel consumption to 14.2mil KL (12.4mil tonnes) in 2022F. B40 trials were supposed to be completed in 2021F.
• Malaysia is expected to complete the implementation of B20 biodiesel by mid-2021F. B20 is expected to increase Malaysia’s biodiesel consumption from 761,000 tonnes for B10 to 1.26mil tonnes for B20. The implementation of B7 in the industrial sector is estimated to absorb 100,000 tonnes of palm oil from the system. B20 was implemented in Sarawak in September 2020. B20 is expected to be implemented in Sabah in January 2021 and Peninsular Malaysia in June 2021.
• On a negative note, we think that the EU’s demand for palm oil would stagnate or decline in 2021F. About 50% of palm oil are used in the biodiesel industry in the EU. Only about 30% are used in the food industry in the EU. We reckon that the EU would follow through on its commitment that the use of palm biodiesel be flat from 2020E to 2025F and thereafter phased to zero by 2030F. The EU’s imports of Malaysia’s palm products fell by 8.3% YoY in 10M2020. Since reaching a high of 2.4mil tonnes in 2015, EU imports of Malaysia’s palm products have been falling almost every year
• In terms of earnings, we believe that demand for downstream products would recover in 2H2021. As vaccines are gradually rolled out in 1H2021, we believe that the demand for non-healthcare oleochemical and refined palm products in the EU would recover in 2H2021. We also expect margin enhancements in 2H2021 as the cost of raw materials eased on higher palm supply. We have assumed IOI’s manufacturing (refining and oleochemical) EBIT margin to be 5.5% in FY21F vs. 4.3% in FY20 while KLK’s manufacturing EBIT margin is anticipated to be 5.6% in FY21F compared with 5.5% in FY20E. Recall that the oleochemical and palm refining industries suffered from high feedstock costs in 2H2020. Also, the oleochemical industry faced lower demand and logistics issues during the Covid-19 lockdown in various countries in 2Q2020. During the lockdown, we understand that sales volume of non-healthcare oleochemical products fell by 15% to 20% from their usual levels.

Source: AmInvest Research - 8 Jan 2021