Highlights

The KL Plantation Index has shown divergence (in terms of trend) since the peak of CPO futures, versus a high correlation of 0.92x between the two during the previous sector down cycle in 2H 2012.

Our technical research team sees downside risk for CPO futures in the near term (with immediate support level at RM2,265/mt, and it would trend down further to RM2,170/mt should the futures break below RM2,265/mt).

Given the less than bullish technical reading on CPO futures as well as the divergence between KL Plantation Index and CPO price, we did an exercise to gauge the potential downside of KL Plantation Index, should the divergence narrow.

Our study indicates that the declining trend of CPO prices to current level would translate to a 7.2% decline to the KL Plantation Index (from current level of 9,000 pts), assuming: (1): the correlation to normalise to the previous down cycle’s level of 0.92x; and (2) CPO futures remain at current level.

In terms of earnings impact, we note that purer upstream players are more sensitive to CPO price movements. Within HLIB’s stock coverage, IJMP is most sensitive to CPO price movement, with every RM100/mt change in our CPO price assumption resulting in an 8.6% change in our FY13/15 core net profit forecast.

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.
• Weaker-than-expected demand for edible oil (including palm oil).
• 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 pick is Genting Plant (BUY; TP: RM12.16).

Source: Hong Leong Investment Bank Research - 21 Jul 2014