Malaysia’s CPO production in Dec19 declined further by 13.3% mom to 1.3m MT, while exports fell marginally by 0.7% mom to 1.4m MT. Given the higher consumption of palm-oil products as compared to production, Malaysia’s inventory level continued to decline in Dec19 to 2m MT, which helped boost CPO prices, in our view. We maintain our OVERWEIGHT rating on the plantation sector and our CPO ASP assumptions of RM2,500-2,600/MT for 2020-21E. KL Kepong and Ta Ann are our top sector BUYs.

Malaysia’s CPO production declined by 13.3% mom to 1.3m MT

Malaysia’s CPO production in Dec19 was lower at 1.3m MT, down 13.3% mom and 26.2% yoy. The drop in CPO production was throughout the country, declining by 16.1%, 12.3% and 8.5% mom to 635.8k MT, 372.6k MT and 325.5k MT in Peninsular Malaysia, Sabah and Sarawak, respectively. We believe production for the next 1-2 months is likely to remain slow given the seasonal monsoon season and upcoming Chinese New Year (CNY) celebration. Overall, Malaysia’s CPO production for 2019 increased by 1.8% yoy to 19.9m MT, underpinned by improving FFB yields and CPO oil extraction rates throughout Malaysia. We expect Malaysia’s 2020E CPO production to be 1-2% lower yoy, due to the lagged effect of the dry weather in 2019, lagged effect of lower fertilizer application and minimal new plantings of oil palm.

Dec19 exports of palm oil down slightly by 0.7% mom to 1.4m MT

Palm-oil exports in Dec19 were slightly lower mom, declining by 0.7% to 1.4m MT. This was due to weaker exports of palm-oil products to our top buyers, which include India (-2.8%), China (-24.6%) and the EU (-18.7%), but this was partially offset by higher exports to countries like Egypt (>100%), Saudi Arabia (+77.1%) and Turkey (>100%). For 2019, total exports rose by 12% yoy to 18.5m MT.

Stock level declined more than expected to 2m MT as consumption surpassed production

Malaysia’s palm-oil inventory declined by another 247.9k MT mom (or -11%) to 2m MT in Dec19, the lowest level since Sep18, given the higher consumption (exports combined with local consumption) of palm-oil products as compared to its production. We expect inventory levels to continue to trend lower in 2020 as we believe demand will surpass production.

Dec19 CPO price averaged at RM2,813/MT, up 12.8% mom

The average MPOB locally-delivered CPO price in Dec19 stood at RM2,813/MT, +12.8% mom (Dec18 CPO ASP: RM1,794.50/MT), while the 2019 CPO price averaged at RM2,079/MT vs. RM2,232.50/MT for 2018. The lower prices yoy in 2019 is partly attributable to the ample supply of other edible oils in the market in the early part of 2019, weak market sentiment as well as the trade tension between the US and China.

CPO prices above RM3,000/MT since end-Dec19

We remain optimistic in terms of the palm oil demand-supply dynamics. We expect the global palm-oil inventory to continue to decline gradually yoy from 2020E onwards with higher exports and higher consumption of palm-oil products. Stronger exports and consumption will likely be supported by the energy market and food industries, in our view. Malaysia targets to raise its biodiesel mandate to B20 by end-2020 (from B10 currently), while Indonesia’s target is B30 (from B20 currently) by Jan20. We believe the anticipation of higher demand growth rate for palm-oil products as compared to the production growth rate has positively catalysed CPO prices. CPO prices have been on a rising trend since midOct 2019 and at end-Dec it rose above RM3,000/MT. We maintain our CPO ASP assumptions at RM2,500/MT-RM2,600/MT for 2020-21E.

Small chance for El Nino to make an appearance in 2020

Based on the US NOAA climate advisory report, the tropical Pacific has remained ENSO-neutral (neither El Nino or La Nina is present), and this condition could potentially continue through the Northern Hemisphere spring of 2020 (c.60% probability) and summer of 2020 (c.50% probability). However, there is a c.25% probability that El Nino could make an appearance in the spring of 2020 (recent anomalous warming across the equatorial Pacific Ocean). The El Niño-Southern Oscillation (ENSO) cycle can greatly influence global weather, as these cycles can alter the normal weather patterns and surface temperatures, which can cause major disruption to the world’s agricultural production and supply.

OVERWEIGHT on plantation sector

Across our coverage, we have BUY ratings on Ta Ann, IJM Plantation, Hap Seng Plantation, KL Kepong and Jaya Tiasa; and HOLD ratings on FGV, IOI Corp, SD Plantation, Genting Plantation and WTK. We are OVERWEIGHT on the plantation sector as we expect 2020 to be a better year for the plantation companies. For sector exposure, we like: (1) KL Kepong (large-cap) as we expect future earnings to improve on the back of higher CPO prices coupled with its cheaper valuation as compared to the other large-caps (SD Plant, IOI Corp and Genting Plant); and (2) Ta Ann (small-mid cap) on the back of its improving earnings (higher log sales volume, and stronger CPO production and ASP).

Key risks for the plantation sector

Key downside risks to our OVERWEIGHT rating on the plantation sector and BUY stock calls include: (i) weaker-than-expected demand and higher-than-expected production lowering prices of vegetable oils; (ii) a decline in CPO production that is not offset by a higher CPO ASP; (iii) delays in the implementation of biodiesel mandates; and (iv) unfavourable policies and taxes. For our HOLD stock calls, the key risks include a strong rebound/decline in the global economy as well as stronger/weaker demand for and prices of vegetable oils.

Source: Affin Hwang Research - 13 Jan 2020