Highlights

CPO futures (3-mth) soared by RM84/mt (or 3.4%) to RM2,547/mt over the last 3 days on several reasons including: (1) Expectation that the monsoon season (which usually begins in Nov) would slow palm production; (2) Indonesia’s commitment to develop palm-based biodiesel; (3) China’s low palm oil inventory (see Figure 1) that may spur buying interest from Chinese customers; and (4) Rally in prices of other vegetable oil including soybean and rapeseed.

Assuming the recent price upswing is sustainable, that pure upstream planters will be the biggest beneficiary from the upswing in CPO price given their earnings sensitivity to CPO price movement (see Figure 2 for earnings sensitivity to CPO price change).

YTD, CPO price averaged RM2,350/mt vis-à-vis our unchanged average CPO price assumption of RM2,500/mt and RM2,600/mt for 2013 and 2014 respectively. Thus, this is somewhat expected.

Our Underweight stance on the sector remains for now, pending more convincing sector re-rating catalysts, which include: (1) Timely implementation of higher biodiesel mandate in Malaysia and Indonesia; (2) Upcoming MPOB statistics (due out on 11 Nov); and (3) More clarity on potential minimum wage hike in Indonesia.

However, from technical perspective, CPO futures did break out from a major reversal trend (inverse head and shoulder). With sentiment likely to stay positive in the short term, there may be potential trading opportunity. For investors with such stance, we believe focus should be on stock with liquidity. For this, we prefer IOI Corp (HOLD; TP: RM5.16).

Catalysts

• 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
• Earlier-than-expected biodiesel implementation in Malaysia and Indonesia.

Risks

• Demand rationing by certain oil consuming countries (such as India) when vegetable oil price skyrockets to certain level; and
• Escalating production cost (in particularly labour costs).

Rating

UNDERWEIGHT

Negatives – (1) Weak global economic outlook; (2) Impending excess supply of CPO; and (3) Expensive valuations.

Positive – CPO is still relatively cheaper than soybean oil.

Top picks

CBIP (BUY; TP: RM3.39).

Source: Hong Leong Investment Bank Research - 31 Oct 2013