Malaysia’s palm-oil inventory in Feb20 declined further to 1.68m MT, its lowest level since Jun17, as total consumption (due to an increase in local consumption despite lower exports) exceeded production. We expect demand for palm-oil products to improve in Mar/Apr due to stocking-up ahead of the Ramadan festivities in Apr/May20 and the potential reconciliation between Malaysia (with the new government) and India. The recent market volatility has put pressure on vegetable oil prices; nevertheless, we still expect 1H20 CPO prices to be supported by the tightness in global supply of the 8 vegetable oils. We keep our OVERWEIGHT rating on the plantation sector and our CPO ASP assumptions of RM2,500-2,600/MT for 2020-21E. KL Kepong is our top sector pick.

February CPO Production Rose 10% Mom to 1.29m MT

Malaysia’s CPO production in Feb20 increased by 10% mom to 1.29m MT after a weak month in Jan20, but declined by 16.6% yoy partly attributable to the effects of dry weather and a lack of fertilizer application in 2019 (due to low CPO prices then). There was an increase in CPO production in Peninsular Malaysia and Sabah, rising by 25% and 0.5% mom, respectively to 707.9k MT and 318.5k MT, while production in Sarawak declined by 9% mom to 262.1k MT. We expect production to continue to pick up gradually as the monsoon season has ended. Overall, Malaysia’s CPO production for 2M20 is down by 25% yoy to 2.46m MT. For 2020, we expect Malaysia’s CPO production to be 1-2% lower yoy (2019: 19.9m MT), due to the lagged effect of the dry weather in 2019, lagged effect of lower fertilizer application and minimal new plantings of oil palm.

Weaker Exports to Top Buyers India, China and the EU

Palm-oil exports in Feb20 declined by 10.8% mom and 18.3% yoy to 1.08m MT, due mainly to the top key buyers China, India and the EU buying less of Malaysian palm-oil products. Exports to China, India and the EU were down by 11.3%, 54.9% and 17% mom, respectively to 156.8k MT, 21.1k MT and 151.8k MT. We still believe that lower exports of palmoil products because of the trade spat with India and the coronavirus in China are likely to be a temporary setback. We expect demand for palm-oil products to improve in Mar/Apr ahead of the Ramadan festivities (which starts in late-April this year) and rapprochement between Malaysia (with its new government) and India, considering India’s decision to lift the safeguard duties on refined palm-oil from Malaysia (which was applied in Sep19 until early Mar20). For 2M20, total exports declined by 23.6% yoy to 2.3m MT.

Stock Levels Declined Further to 1.68m MT, the Lowest Since Jun17

Despite the decline in exports, Malaysia’s palm-oil inventory in Feb20 declined by another 73.8k MT mom (or -4.2%) to 1.68m MT, the lowest level since Jun17, given the higher total consumption (higher local consumption while exports declined) of palm-oil products as compared to its production. We expect the downtrend in palm-oil inventory level to continue for the next 1-2 months as total consumption is expected to outweigh production.

CPO Price in Feb20 Averaged at RM2,714.50/MT, Down 9.9% Mom

The average MPOB locally-delivered CPO price in Feb20 stood at RM2,714.50/MT, -9.9% mom (Feb19 CPO ASP: RM2,100.50/MT). Malaysia’s 2M20 CPO prices averaged at RM2,846/MT, higher by 38.3% yoy as compared to RM2,057.50/MT for 2M19.

Despite the Tightness in Edible Oils, CPO ASP Still at Risk

The anticipation of tight supply-demand dynamics and lower stock/usage ratios of 8 vegetable oils, including palm oil, have helped lift prices from midOct19 to Jan20, hitting a high of RM3,100/MT in early Jan20. However, CPO prices have since retreated and are hovering at the RM2,300- 2,400/MT levels, partly due to external factors which include the uncertainty about the impact of Covid-19 on the global economy and the crude oil price crash because of the price war between Saudi Arabia and Russia. While we remain optimistic that CPO prices would recover due to expectation of supply tightness for the 8 vegetable oils, especially in 1H20, and for demand to improve in the next 1-2 months ahead of the Ramadan festivities, any prolonged Covid-19 outbreak, oil price crisis or continued weakness in market sentiment would likely put our 2020E CPO ASP forecast of RM2,500/MT at risk.

ENSO-neutral Is Still Favoured

Based on the US NOAA climate advisory report, the tropical Pacific is slightly warmer than average but it does not meet the El Nino criteria yet. Overall, the combined oceanic and atmospheric system remained consistent with ENSO-neutral (neither El Nino nor La Nina is present), and this condition may continue through the Northern Hemisphere spring of 2020 (c.60% probability) and summer of 2020 (c.50% probability). The ENSO cycle can greatly influence global weather, 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, FGV and Jaya Tiasa, and HOLD ratings on IOI Corp, SD Plantation and Genting Plantation. We are OVERWEIGHT on the plantation sector as we expect 2020 to be a better year for the companies. 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 sector average; 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 higherthan-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 - 11 Mar 2020