CPO production in June declined for the third consecutive month, by 12.6% mom and 12% yoy to 1.33m MT, partly attributable to the Hari Raya Aidilfitri festive month. Exports of palm oil were also lower mom and yoy at 1.13m MT, after the reinstatement of the palm-oil export tax in May. Given the weaker exports, palm-oil inventory increased for the first time this year to 2.19m MT. Overall, we maintain our NEUTRAL plantation sector rating. Our top buys for the sector are FGV and Genting Plantation.

CPO Production Down Mom and Yoy to 1.33m MT

Malaysia’s CPO production declined by 12% yoy and 12.6% mom to 1.33m MT in June, its lowest level since February 2017. This is also the third consecutive mom decline in CPO production, which we believe was partly attributable to workers going back to their hometowns for the Hari Raya Aidilfitri festivities. FFB yields were lower throughout Peninsular Malaysia, Sabah and Sarawak, declining by 12.2%, 22.9% and 6.9% yoy respectively to 1.15 MT/ha, 1.18 MT/ha and 1.21 MT/ha. For 1H18, total CPO production is still up by 2.3% yoy to 8.92m MT. We expect Malaysia’s CPO production to improve in 2H18 and we forecast the production in 2018E will reach above the 20m MT level (2017: 19.92m MT) for the first time (Oil World 2018 CPO production forecast: 20.5m MT).

Inventory Rises on Lower Exports

Palm-oil exports in June declined by 12.6% mom (and -18.2% yoy) to 1.13m MT. This is the lowest level of exports since February 2017, as key buyers including China, Pakistan, Turkey and the EU bought less of Malaysia’s palm-oil products. However, this was partially offset by higher palm-oil exports to India and Vietnam. Exports to China, Pakistan, Turkey and the EU were down by 19.4%, 23.3%, 50.7% and 0.6% mom respectively, while exports to India and Vietnam increased by 112% and 18.7% mom, respectively. However, for 1H18, total exports were still up by 5.1% yoy to 8.23m MT, partly due to the suspension of the export tax on palm oil by the Malaysian Government for the first four months of 2018, which increased demand. Palm-oil inventory in June went up slightly by 0.8% mom to 2.19m MT, the first increase in the past 6 months.

1H18 CPO ASP at RM2,420.50/MT

Average MPOB locally-delivered CPO prices in June stood at RM2,324/MT, down by 3% mom (June17 CPO ASP: RM2,686/MT). For 1H18, CPO prices averaged RM2,420.50/MT vs. RM2,944.50/MT for 1H17. Prices of most vegetable oils, including palm oil, have been under pressure with the improvement in global production coupled with the trade tensions between the US and China. Nevertheless, we believe that palmoil prices will be supported by healthy demand in the food industries as well in the energy market as it become attractive relative to fossil fuels.

ENSO-neutral Expected Through Summer 2018

Based on the US NOAA climate advisory report, the tropical Pacific has remained ENSO-neutral. The neutral condition is likely to continue through the Northern Hemisphere summer 2018. Thereafter, there is a 50% chance for El Nino to make an appearance during the fall and rising to a c. 65% possibility by winter 2018/19.

Maintain NEUTRAL on Our Sector Rating and Stock Calls

As we expect CPO production to continue to improve (barring no extreme weather condition hitting the palm-oil producing countries), the supply of palm oil in the market could potentially improve but put downward pressure on CPO prices. Our CPO ASP assumption for 2018-19E remains at RM2,600/MT-2,500/MT (2017 CPO ASP: RM2,783/MT). Sector-wise, we maintain our NEUTRAL rating.

We make no changes to our earnings forecasts for the plantation companies we cover. Across our coverage universe, we have BUY ratings on Genting Plantation and Felda Global (FGV); HOLD ratings on KL Kepong, SD Plantation, IJM Plantation, Hap Seng Plantation, Ta Ann and Jaya Tiasa; and SELL ratings on IOI Corp and WTK (please refer to the peer comparison table on page 1).

For plantation-sector exposure, we like FGV and Genting Plantation. We believe FGV’s earnings will grow going forward on the back of higher FFB and CPO production as well as a better contribution from the sugar business. Also, we like FGV as management is more focused on improving the core business, improving operational excellence and optimizing financial and human capital. Meanwhile, we like Genting Plantation as we expect higher FFB and CPO production coupled with an increase in contribution from the downstream plantation segment to drive earnings growth going forward.

Key Risks for the Plantation Sector

Key downside risks to our NEUTRAL rating on the plantation sector and stock calls include: (i) weaker-than-expected demand and higher-thanexpected production lowering prices of vegetable oils; (ii) a decline in CPO production that is not offset by higher CPO selling prices; (iii) delays in the implementation of biodiesel mandates in Indonesia and Malaysia; and (iv) unfavourable policies and taxes. Meanwhile, key upside risks include a strong rebound in the global economy as well as demand and prices of vegetable oils.

Source: Affin Hwang Research - 11 Jul 2018