We believe CPO price will remain elevated (at above RM3,000/mt mark) until 1Q21. Beyond 1Q21, we anticipate CPO price to soften from 2Q21 onwards, on the back of better supply outlook for major edible oils, which will in turn result in more balanced demand-supply dynamics. Besides, current high POGO spread and price spread between CPO and soy oil also point towards a weaker CPO price. We raise our average CPO price assumptions for 2020-2022 to RM2,700/tonne (from RM2,350/tonne in 2020 and RM2,400/tonne in 2021-22). We maintain our Neutral rating on the sector, as we believe current high CPO price will not sustai n over the longer term. For exposure, our top picks are Hap Seng Plantations (BUY: TP: RM2.17), IJM Plantations (BUY: RM2.17) and TSH (BUY: RM1.38).

Strong CPO price sentiment to sustain into 1Q21. CPO price will likely remain elevated until 1Q2021, supported by (i) concerns on palm supply tightness in both Malaysia and Indonesia, (ii) La Nina phenomenon, which has in turn resulted in slow soybean planting progress in Brazil and lower soybean yield in US, and (iii) low inventory level for edible oil in major edible oil consuming countries, which will continue to underpin demand for edible oils including palm oil.

We expect softer CPO price beyond 1Q21. We anticipate CPO price to soften from 2Q21 onwards, on the back of better supply outlook for major edible oils, which will in turn result in more balanced demand-supply dynamics.

Supply of major edible oils to return to normalcy in 2021. We believe supply of major edible oils will gradually return to normalcy from 1Q21, supported by (i) higher palm production in Malaysia and Indonesia from Mar-21 (based on the assumptions that labour shortage in Malaysia will gradually ease from 2021 onwards and La Nina does not strengthen further), and (ii) higher soybean production in 2021. We note that Oilworld is still projecting total soybean supply in the world to increase by circa 7% to 361.8m tonnes in 2020-2021, supported mainly by higher planting acreage.

CPO currently trading at premium to soy oil. CPO is currently trading at premium to soy oil vis-à-vis a US$100/tonne discount to soy oil (historical 5-year average). Given our anticipation of a recovery in palm production in 2020, we believe the price spread between CPO and soy oil will start normalising once palm production shows signs of improving (expected by Mar-21), hence resulting in CPO price trending downwards.

Viability of biodiesel remains questionable. We note that spread has increased further following the spike in CPO price, and this raises questions on viability of existing biodiesel mandates (in Indonesia, Malaysia, Brazil, US, and Europe).

Forecasts. We raise our average CPO price assumption to RM2,700/tonne for 2020 (from RM2,350/tonne) and 2021-22 (from RM2,400/tonne), to reflect our more positive view on palm oil’s demand outlook. Following the upward revision in our average CPO price assumptions, we raise our core net profit forecasts for plantation companies under our coverage.

Rating changes. We revise our TPs on plantation stocks higher by 0-40%, following the upward revision to our core net profit forecasts. Post revisions in TPs, we upgrade our ratings on HSP, IJMP and KLK (from Hold to BUY). Despite the upward revision in our CPO price assumptions, we maintain our Neutral rating on the sector, as we believe current high CPO price will not sustain over the longer term. For exposure, our top picks are HSP (BUY: TP: RM2.17), IJMP (BUY: RM2.17) and TSH (BUY: RM1.38).

Source: Hong Leong Investment Bank Research - 7 Dec 2020