Highlights

Higher chance of El Niño in mid-2014… Australia’s Bureau of Meteorology, the US Climate Prediction Center and Japan’s weather bureau recently highlighted that the chance of El Niño returning in mid-2014 has increased (although the intensity of the event is uncertain). An El Niño phenomenon (which typically occurs every 2-7 years), generally triggers drought in Australia, Southeast Asia, India and Africa while bringing rain to South America, hence affecting supplies and prices of vegetable oil (including palm oil).

There were three El Niño events since 2002 (see Figure 1). With the exception of the most recent El Niño event (May-09 to Mar-10, as CPO price went up much earlier on QE2 speculation), the two other El Niño events have resulted in CPO prices rising by 33-44%.

Maintain 2014-2015 average CPO price projection. We are keeping our average CPO price projection of RM2,700/mt for 2014 and 2015 for now, pending for a more convincing data that supports the potential El Niño event (as there has been false signals in the past). In the absence of weather disruptions, we believe it is unlikely for CPO price to run-up further from current level, as: (1) Biodiesel policy alone is insufficient to boost CPO price higher (unless Brent crude price advances further); and (2) The diminished CPO price attraction over soyoil (see Figure 3).

Nevertheless, CPO price may overshoot on the upside given the current bullish undertone. This provides trading opportunity and as such, we believe focus should be on plantation stocks with liquidity (see Figure 3 for plantation stocks with high liquidity).

Maintain our Neutral stance on the sector.

Catalysts

• Earlier-than-expected recovery in the world’s major economies, resulting in higher edible oil demand and prices;
• Timely implementation of higher biodiesel mandate in Indonesia and Malaysia.
• Weather uncertainties revisit, which would result in supply distortion, hence boosting prices of edible oil.

Risks

• Higher-than-expected soybean yield and soybean planting, resulting in lower soybean prices, hence prices of CPO.
• India imposes higher import duty on CPO.

Rating

NEUTRAL

Positive – (1) Improved demand outlook; and (2) Better production cost visibility.

Negatives – (1) Price attractive of CPO diminishes; and (2) Pricey valuations for the sector.

Top picks

For exposure in the sector, our top picks are Genting Plant (BUY; TP: RM12.12) and TSH Resources (T. BUY; TP: RM3.13).

Source: Hong Leong Investment Bank Research - 27 Feb 2014