We believe it is still too early to turn bearish on plantation sector, as crop recovery remains uncertain at this juncture, as (i) palm output recovery in Malaysia may disappoint, and (ii) La Niña may return for a third year in a row by Sep/Oct 2022. This, if happens, this will likely affect palm production in Malaysia and Indonesia and upcoming soybean planting in South America (in particular, Brazil). Besides, CPO price discount to soybean oil has recently widened to US$400/mt and this will likely spur buying interest. Maintain 2022-24 CPO price assumptions of RM5,500/4,500/4,500 per tonne and OVERWEIGHT stance on the sector. For exposure, we prefer integrated players such as KLK (BUY; TP: RM32.43) and IOI (BUY; TP: RM5.07) over purer upstream players, as integrated players tend to deliver more stable financial performance amidst volatile palm product price trend.

Sharp correction in CPO price. Despite having rebounded by 4.5% (at RM4,700/mt) yesterday, CPO futures (3-months) still fell by 17.5% from last Friday’s closing (see Figure #1), due to (i) sharp correction in crude oil and other competing vegetable oils arising from concerns on global economy slowdown; (ii) concerns on rising palm oil exports from Indonesia (following the Indonesian government’s move to flush out palm oil inventories accumulated since Mar-22); and (iii) easing concerns on labour shortage in Malaysia (as the Human Resource minister recently mentioned that issues surrounding the recruitment of foreign workers from Indonesia, Bangladesh and Cambodia will be resolved soon).

Too early to turn bearish on the sector yet. While yesterday’s rebound may not be sustainable (due to Indonesia’s policy to flush out palm oil inventories), we believe it is still too early to turn bearish on plantation sector, as crop recovery remains uncertain at this juncture, due to the following reasons as:

1. Palm output recovery in Malaysia will likely disappoint. Due to two key factors: (i) at this juncture, it remains uncertain if foreign labour will arrive at Malaysian shore just in time for its seasonal peak production cycle. And even if they do, the amount of foreign labour arrival may not be sufficient; (ii) fertiliser shortfall and high fertiliser prices will likely result in under-application of fertiliser (particularly among the smallholders, which account for ~40% of the planted area in Malaysia); and

2. La Niña may return for a third year in a row. Several weather forecasters, including Australia Bureau of Meteorology (BOM), National Oceanic and Atmospheric Administration (NOAA), and US Climate Prediction Center (CPC) recently suggested that the odds of La Niña returning in later part of 2022 (i.e. Sep/Oct 2022) have increased. The onset of La Niña (if it develops in Sep/Oct 2022) will likely affect (i) palm production (as it coincides with seasonal pick-up in palm production cycle); and (ii) upcoming soybean planting in South America (in particular, Brazil, which accounted for about 36% of the world’s total soybean output in 2021), as it coincides with soybean planting season in Brazil. Impact on production aside, we note that prices of CPO and soybean tends to strengthen as La Niña (as well as El Niño) sets in and weaken when the weather anomaly subsides (see Figures #2-3).

Lingering supply concerns aside… We note that CPO price discount to soybean oil has recently widened to US$400/mt (see Figure #5). This will likely spur buying interests, particularly when (i) wide price gap between the two sustain for a longer period; and (ii) inventory levels remain low among key consuming countries.

Forecast. Maintain 2022-24 CPO price assumptions of RM5,500/4,500/4,500 per tonne.

Maintain OVERWEIGHT. We maintain our OVERWEIGHT stance on the sector, supported by (i) our expectation of CPO price, which will likely remain lofty (given the reasons mentioned above, (ii) more palatable valuation (following recent share price correction), and (iii) easing ESG concerns. For exposure, we prefer integrated players such as KLK (BUY; TP: RM32.43) and IOI (BUY; TP: RM5.07) over purer upstream players, as integrated players tend to deliver more stable financial performance amidst volatile palm product price trend.

Source: Hong Leong Investment Bank Research - 24 Jun 2022