- Average CPO price assumption revised downwards. We are now assuming an average CPO price of RM2,400/tonne for 2013F with lower prices for companies with higher exposure to Indonesia vs. RM2,800/tonne previously. For 2014F, we assume an average CPO price of RM2,500/tonne (vs. RM3,000/tonne previously). In spite of the downward revision in average CPO price, we remain positive on the plantation sector in anticipation of a recovery in the coming months. We also believe that share prices have bottomed out.

- Share prices are leading indicators. Looking at past trends, we find that share prices have moved ahead of CPO prices by one to three months. Although CPO prices have been bouncing between RM2,200/tonne and RM2,400/tonne for the most parts in the past five months, we reckon that share prices should start reflecting a rebound in CPO prices soon. Hence, we are sticking to our contrarian view on the plantation sector.

- Reacting before CPO prices. In May 2006, the KL Plantation Index reached a high of 3,430 before correcting 12.3% to a low of 3,007 in June. The CPO price achieved a high of RM1,541/tonne in July 2006 before falling 3.1% to RM1,494/tonne in October. At the height of the run in equities from 2007 to 2008, the KL Plantation Index rose almost two-fold to 8,823 in January 2008. This was followed by CPO prices which reached an all-time high of RM4,203/tonne in March 2008.

- In recent times, the time lag between equity and CPO prices has narrowed to as short as a month. In February 2011, the KL Plantation Index climbed to a high of 8,092, followed by CPO price, a month later. In March 2012, the index of share prices of planters increased to 8,741, while CPO price expanded to RM3,568/tonne in April.

- At inflection point. We believe that CPO prices would turn up in the short term as demand picks up ahead of the festive season in 3Q2013. At the same time, palm oil production in Malaysia and Indonesia are not anticipated to hit its seasonal peak yet. These two scenarios are envisaged to help alleviate palm oil inventory in the short term. Palm oil inventory stood at 1.93mil tonnes as at end-April 2013. A weaker supply of soybean oil, underpinned by a decline in crushing in China, is also expected to support CPO prices. Soybean crushing in China is envisaged to be affected by the H7N9 bird flu, which has killed more than 20 people.

- Tree stress in Indonesia this year? Another factor aiding the recovery of CPO prices is the weak increase in palm oil production in Indonesia. After two good years of bumper growth, some of the Indonesian planters are facing tree stress in 2013F. As an indication, First Resources’ FFB production shrank 4% YoY in 1Q2013 while Indofood Agri Group’s output was flat. Wilmar’s FFB production (Malaysia and Indonesia) inched up 4% YoY in 1QFY13. On the other hand, Astra Agro Lestari’s group FFB production (including plasma) expanded 9.8% YoY in 1Q2013, while BW Plantation’s FFB output was 24% higher.

- Stock pick. We continue to like Genting Plantations (GenP) for its healthy FFB output growth of 15% to 20% for FY13F. There is a possibility that the group’s plantation division in Indonesia would break-even in FY13F compared to a loss of RM19.6mil in FY12. Production costs are envisaged to remain flat at RM1,300/tonne or marginally lower. Indications from planters are that fertiliser costs have shrank by as much as 10% while the impact of the minimum wage on Malaysian planters is not expected to be significant.

Source: AmeSecurities