Palm oil inventory fell by a slower-than-expected pace to 2.17m tonnes as at end-May 18 and marked the fifth consecutive month of decline. CPO production is likely to stay weak in Jun 18 on fewer harvesting rounds due to the Hari Raya holidays. A build-up in inventory is likely to come in July-August on higher production. CPO prices are expected to trend in the range of RM2,350-2,500/tonne. Crude oil price at >US$70/bbl is the main supporting factor now. Maintain MARKET WEIGHT.

WHAT’S NEW

• Inventory decreased marginally in May 18. Malaysia’s palm oil inventory decreased for 5 consecutive months to 2.17m tonnes (-0.5% mom) in May 18. The inventory level was higher than market expectations of 2.09m-2.13m tonnes due to weaker-than-expected exports and stronger-than-expected CPO production.
• CPO production was weaker mom and yoy in May 18. CPO production registered a yoy decline of 7.8% in May 18, which is the first yoy decline since Jun 17. The decline in CPO production could have been due to fewer working days in May 18 due to the public holidays after GE14, the Harvest Festival Holiday in East Malaysia and weaker FFB yield. The last time that we saw a mom decline in May production was in 2003.
• Exports declined after resumption of export duty. Exports for May 18 were at 1.29m tonnes, the lowest since Apr 17. The weaker mom and yoy exports were mainly due to weaker imports from India and the EU. India recorded a 75% mom drop in palm oil imports as India front-loaded imports in Jan-Apr 18 when Malaysia suspended CPO export duty. India’s imports doubled yoy in Jan-Apr 18.

ACTION

• Maintain MARKET WEIGHT. Malaysia plantation stocks are now trading at a sector PE of 22x which is close to -1SD below its five-year mean. The valuation correction over the last one year could have factored in the lacklustre CPO price outlook. CPO price weakness could have factored in the expected increase in FFB production in 2H18. Nevertheless, CPO prices are likely to trade sideways in the near-term, and we are awaiting stronger rerating catalysts, eg much stronger biodiesel demand or disappointing production.
• The plantation sector is more defensive and less affected by the high market volatility due to a change of government. Among big-caps, we like Genting Plantations where its earnings growth is supported by FFB production growth from its Indonesia estates.
• Maintain BUY on Kim Loong and Sarawak Oil Palms, and SELL on Sime Darby Plantation and IOI Corporation.

ESSENTIALS

• CPO production expected to be flat in Jun 18. We are expecting CPO production to be flat in Jun 18 on fewer harvesting rounds due to the Hari Raya holidays. Meanwhile, CPO production is likely to pick up from July and possibly peak in Sep-Oct 18 as we enter the seasonal peak production period.
• CPO production on track to meet expectations. For 5M18, CPO production was at 7.59m tonnes, accounting for 37% of Oil World’s 2018 CPO production estimate of 20.55m tonnes. In the past 10 years, CPO production for January to May accounted for 34-39% of full-year CPO production.
• Biodiesel exports increased yoy ytd. Exports of biodiesel from Malaysia increased 28% mom to 36,822 tonnes (+15% yoy) for May 18. Exports of biodiesel from Malaysia rose 26% yoy to 157,995 tonnes in 5M18 (5M17: 125,609 tonnes). We are expecting biodiesel exports to continue to increase in coming months as biodiesel demand is expected to rise with the increase in crude oil prices. This has made the biodiesel programme more financially viable.
• Moderate growth in exports for Jun-Jul 18. According to Intertek and AmSpec, palm oil exports decreased 12.6% mom and 20.1% mom for the first 10 days in Jun 18. Demand for palm oil is likely to stay subdued in Jun 18, and likely improve in Aug-Sep 18 as we enter the festive season – Moon Cake Festival in Sep 18 and China Golden Week in Oct 18.

ASSUMPTION CHANGES

• Maintain 2018 CPO price assumption. To date, CPO ASP is at RM2,437/tonne (-18.3% yoy). For 2018, we maintain our forecast at RM2,400/tonne as CPO prices could trend as low as RM2,250/tonne once production picks up in 2H18. We also maintain our 2019 CPO price assumption at RM2,500/tonne.
• CPO prices could trend sideways in the near term. CPO prices are negatively correlated with palm oil inventory levels. As inventory is expected to increase in 2H18, CPO prices are expected to trend in the range of RM2,350-2,500/tonne in 2Q18 and RM2,250-2,600/tonne in 2H18. CPO prices could trend even higher in end-4Q18 due to the low production season.

SECTOR CATALYSTS

• Stronger-than-expected discretionary biodiesel consumption.

RISKS

• Backtracking of biodiesel mandates in Indonesia.

Source: UOB Kay Hian Research - 12 Jun 2018