Highlights

• Inventory level stood at 2.17m tonnes for Feb 16, declining by 6.1% mom, as CPO production continued to trend downwards amid weaker exports and lower domestic consumption. The inventory level was, however, higher than market expectation of 2.11m tonnes.

• CPO production lower than market expectation. CPO production of 1.04m tonnes for Feb 16 (-7.7% mom, -7.0% yoy) was lower than market expectation of 1.09m tonnes. Going into Mar 16, CPO production is expected to pick up mom due to more harvesting days but lower yoy due to the lagged impact from El Nino especially Sabah area. Based on our understanding, Sabah is still experiencing dry weather now. This could further affect production in Sabah that has been suffering prolonged dry weather since 1H15.

• Exports to return after winter season but at a slower pace. According to Intertek, Mar 1-10 exports were up by 31% mom to 327,551 tonnes. However, we believe that consuming countries are likely to drawdown their high inventory level of edible oils before replenishing. Also, narrowing discount gap to soybean oil price would prompt price sensitive countries to switch to soybean oil. Further to that, demand from China is likely to be weak in the coming months due to the release of state reserve of rapeseed oil.

• Inventory drawdown to continue. As production is likely to stay low in 1H16 due to the severe dryness in 2015, we believe that inventory level would continue to be drawn down in 2Q16. This would provide a support to the CPO price performance in 1H16. YTD spot and 3-month future CPO prices were up by 12.5% and 4.5% respectively to RM2,477/tonne and RM2,546/tonne.

Catalysts

• Revisit of weather uncertainties, which would result in supply distortion, hence boosting prices of edible oil.

• Severe-than-expected El Nino impact on FFB yield.

Risks

• Higher-than-expected soybean yield and soybean planting, resulting in lower soybean prices, hence prices of CPO.
• Backtracking of biodiesel mandate in Indonesia.
• Imposition of higher import duty on CPO by India.
• Escalating production cost (particularly labour cost).

Rating

NEUTRAL

• We maintain Neutral on the sector with unchanged CPO Price assumption of RM2,400/tonne for 2016.

Positives

• Long term sector outlook remains favourable.

Negatives

• Weak demand and high inventory in near term.

Top picks

• CBIP (BUY; TP: RM2.30)

Source: Hong Leong Investment Bank Research - 11 Mar 2016