Highlights

CPO climbs the most since early-June. CPO price futures (3-month) advanced by RM67/tonne (2.8%) to RM2,434/tonne, the highest since early-Jun, as hot spell in the US Midwest threatened to curb soybean yields and signaled tighter global edible oil supplies (which in turn sent soybean oil price higher by 3.2% to US$44.38/bushel). Higher soybean oil price aside, we believe the uptrend in CPO price was also partly driven by: (1) The European Union’s recent decision to free Indonesian biofuel from provisional countervailing duties (as its preliminary investigation reveals insignificant subsidy); and (2) The weakened RM against the US$, which makes palm oil cheaper relative to other oilseeds.

Nevertheless, we believe the recent positive news flows will unlikely bring CPO price to a much higher level and we are still keeping our Underweight stance on the sector due to: (1) Seasonally higher CPO production (which has already started since Jul); (2) The depreciation of Rupee against RM and Rupiah (vs. RM: -5.3% mom; vs. Rupiah: -3.2% mom) may hurt demand for CPO in India (one of the world’s largest palm oil consuming countries). In 2012, India accounted for 15% of Malaysia’s palm oil exports; and (3) Palm oil consumption growth in China will likely taper off post Aug on the back of the absence of seasonal demand (we believe demand from China may still expand in Aug on the back of stock replenishing ahead of mid-Autumn festival) and the clamp down of shadow financing activities will likely curb inventory replenishing activities there.

We are still keeping our average CPO price projections unchanged, at RM2,500/tonne and RM2,600/tonne for 2013 and 2014 respectively, pending further review but with downward bias for 2013.

With the subdued CPO price outlook, we believe earnings growth of plantation companies will be coming from: (1) CPO output growth; (2) Downstream segment expansion in Indonesia that will complement the upstream plantation segment there; and (3) Companies with significant property land bank (where property earnings will cushion earnings from current low CPO price environment).

Catalysts (downside)

• Higher-than-expected soybean yield and soybean planting, resulting in lower soybean prices, hence prices of CPO;
• Longer-than-expected CPO price recovery path.

Risks

• Earlier-than-expected recovery in the world’s major economies, resulting in higher edible oil demand and prices;
• Weather uncertainties revisit, which would result in supply distortion, hence boosting prices of edible oil; and
• Further action from the Malaysian Government to boost competitiveness of downstream plantation players.

Rating

UNDERWEIGHT

Negatives – (1) Weak global economic outlook; and (2) Impending excess supply of CPO.

Positive – CPO is still relatively cheaper than soybean oil.

Top picks

CBIP (BUY; TP: RM3.39) and Genting Plantations (HOLD; TP: RM10.57).

Source: Hong Leong Investment Bank Research - 27 Aug 2013