Investment Highlights

• NEUTRAL with a lower 2018F average CPO price assumption. We are now assuming an average CPO price assumption of RM2,450/tonne for 2018F vs. RM2,650 previously. According to the MPOB, average spot CPO price was RM2,455/tonne in 4M2018, 19.1% lower than the RM3,034/tonne recorded in 4M2017 (2017: RM2,792/tonne). Most plantation companies are selling CPO at spot prices.

• Barring an El Nino, we are NEUTRAL on the plantation sector as there is no catalyst for a re-rating of CPO prices. We believe that negative supply factors would outweigh demand. In addition, falling US soybean prices resulting from the trade war with China is expected to exert downward pressure on CPO prices.

• GenP for exposure to the plantation sector. Although we do not have any BUY recommendation, we would recommend Genting Plantations (GenP) for investors, who would like exposure to the plantation sector. We like GenP for its low production cost per tonne of RM1,300 in Malaysia, young oil palm trees in Indonesia and recurring income from the Genting Highlands and Johor Premium Outlets. On the flip side, GenP may no longer be an indirect beneficiary of the high-speed rail (HSR) project in Johor as the project may be scrapped. To recap, an HSR station was supposed to be built at the group’s Pura Kencana residential property project in Batu Pahat.

• Supply factors:

• Industry CPO production is forecast to rise in 2H2018. The increase in CPO supply is anticipated to exert downward pressure on CPO prices in 2H2018. In line with seasonal factors, CPO production in Malaysia and Indonesia is expected to rise from now until late 3Q or early 4Q2018. 2H is envisaged to account for 55% or 60% of the full year’s production while 1H would account for the balance 40% to 45%.
  We think that the highest level of palm production would take place in either September or October in 2018F. In three out of the past six years, Malaysia achieved its highest level of CPO output in October. The highest level of CPO inventory for the year in Malaysia usually takes place in November or December. Record high inventory in Malaysia was 2.91mil tonnes, which was registered in November 2015. Malaysia’s palm stockpiles stood at 2.17mil tonnes as at end-April 2018 compared with the five-year average of 2.02mil tonnes.
  According to Oil World, CPO production in Malaysia is forecast to increase by 3.9% from 19.92mil tonnes in 2017 to 20.7mil tonnes (5M2018: 5.3% YoY) in 2018F. In Indonesia, CPO output is estimated to rise by 5.4% from 36.8mil tonnes in 2017 to 38.8mil tonnes in 2018F.

• FFB production of companies in our coverage to improve by 5% to 19% in 2018F, contributing to the industry production growth. GenP is forecast to achieve the highest FFB production growth of 19% in 2018F. The 5% to 19% increase in FFB output in our stock universe is envisaged to be underpinned by a recovery in FFB yields and/or an increase in mature areas. GenP’s robust FFB production growth of 19% in FY18F is mainly driven by the acquisition of 12,893ha of oil palm estates in South Kalimantan from Lee Rubber.

• Global soybean production to increase but inventory to decline on higher exports and domestic crushing. Based on the latest report, the USDA forecasts global soybean output to improve by 5.5% from 336.7mil tonnes in 2017/2018F to 355.24mil tonnes in 2018F/2019F. The expansion in global soybean production in 2018F/2019F is mainly due to Argentina. Soybean output in Argentina is forecast to rise by 51.4% from 37mil tonnes in 2017/2018F to 56mil tonnes in 2018F/2019F as yields recover from the drought. On the flipside, the USDA has forecast a 2.5% drop in output in the USA in 2018F/2019F dragged by lower yield and planted areas.
  In spite of the higher soybean production, global inventory is anticipated to fall by 5.9% to 87.0mil tonnes in 2018F/2018F. This is due to increased domestic crushing activities and exports. The USDA has forecast global soybean exports to go up by 6.7% to 162.37mil tonnes in 2018F/2019F while domestic crushing activities are estimated to improve by 4.6%.

• El Nino to return? El Nino may hit CPO supply, which would push up CPO prices. Weather agencies in the USA are predicting a 50% possibility that El Nino would return. On 19 June 2018, Australia’s Bureau of Meteorology said that although oceanic indicators are neutral, there are signs of an El Nino development. Also, the likelihood of an El Nino in 2018 is 50%. We believe that it is difficult to predict weather. There have been instances of wrong weather predictions. Hence, we will not be revising our assumptions on the companies’ FFB production for now.

• Demand factors:

• We expect global demand for palm oil to be positive in 3Q but soft in 4Q. We reckon that palm demand would be positive in 3Q2018 due to the Deepavali and Mooncake festivities. Subsequently, palm demand may taper off towards the end of the year as the winter season sets in China.
  Also, restocking activities in India and China may not be as strong as 1Q2018 as there are ample inventories of edible oil. As at 8 June 2018, palm inventory at the major ports in China were 610,500 tonnes vs. 543,500 tonnes a year ago. Inventory of edible oils at the ports and pipelines in India stood at 2.3mil tonnes as at 1 May 2018 compared with 2.1mil tonnes as at 1 May 2017. Malaysia’s palm exports to China and India expanded by 16.1% and 45.8% YoY respectively in 5M2018.
  In spite of India’s hike in import duties on palm products in January 2018, India’s demand for palm oil was robust in 1Q2018. From November 2017 to March 2018, India’s imports of crude and refined palm products rose by 6.8% YoY to 3.8mil tonnes. We attribute this to a shortage of domestic supplies of edible oils amidst healthy demand for frying oil from a growing population.

• Biodiesel demand in Indonesia to increase due to the mining and railway sectors. Demand for palm oil from the biodiesel segment in Indonesia is expected to help absorb the increase in CPO supply in the country. Biodiesel is targeted to take up about 2.8mil tonnes of palm oil from the system in Indonesia in 2018F vs. 2.2mil tonnes in 2017. The additional usage of biodiesel in Indonesia is envisaged to come from the mining and railway sectors. The Indonesia government has said that it would be granting subsidies for biodiesel to be used in these industries. In total, the Indonesia Estate Crop Fund has allocated 9.4 trillion rupiah or US$700mil as biodiesel subsidies for 2018F. Biodiesel producers in Indonesia include Musim Mas and Wilmar International.

• EU’s proposed ban on palm biodiesel would take time. A ban, if any, would only take place in year 2030F. Hence, there is still time for Indonesia and Malaysia to find new markets such as Africa and the Middle East. Indonesia has said that it may retaliate by lodging a complaint with the WTO and not buying certain EU products. It is estimated that almost half of the palm oil in the EU are used to make biodiesel. Malaysia and Indonesia exported 7.0mil tonnes of palm oil to the EU in 2017.

• Negative factor – small discount to soybean oil. Due to the small price discount, buyers may prefer to use or switch to soybean oil instead of palm oil. As at 19 June, the price discount between the two commodities was 11.4% or US$73/tonne compared with the six-year average of 15.3% or US$155/tonne. However if the MYR continues to depreciate against the USD, this would widen CPO’s price discount with soybean oil and help improve demand.

• Palm oil is a small beneficiary of China’s 25% tariff on US soybean. If China’s soybean oil supplies drop due to the 25% tariff on US soybean, CPO would benefit as it would be able to replace the oil component of soybean. CPO is not expected to be a complete beneficiary as soybeans are bought primarily to be crushed into feedmeal in China. Palm kernel expeller is not widely used as feedmeal in China as it lacks certain nutrients. The direct beneficiaries of China’s proposed tariff on US soybean are soybean producers in Brazil and Argentina, and substitutes for soymeal such as rapeseed.

Source: AmInvest Research - 11 Jul 2018