Malaysia's CPO inventory level for Sep-12 jumped 17% MoM to 2.48m mt and this was higher than the consensus' estimate of 2.45m mt due to a higher than expected CPO production. As the production growth of 20% MoM exceeds the exports growth of 5% MoM, the stocks-to-usage ratio jumped significantly to 12.4% in Sep-12 (from 10.9% in Aug-12). We think that Oct inventory should be higher MoM and to reach another new high of 2.6m-2.8m mt before declining in Nov in line with the seasonal pattern. That said, we believe that most of the negative news from the high inventory level has been priced in as CPO prices are currently at a high discount of US$350/mt against soybean oil. In addition, the higher usage of biodiesel locally and stronger support from the Malaysia-Indonesia collaboration to defend falling prices should bode well for CPO prices. Overall, we  maintain our NEUTRAL call on the plantation sector  as the short term CPO price weakness should continue in Oct but to rise from Nov onwards once the high inventory starts to go lower. After adjusting for the higher inventories, our average CPO price estimate for CY12 has been cut to RM2,975/mt (from RM3,150/mt) and CY13 estimate cut to RM3,000/mt (from RM3,100/mt).  As a result, we have lowered the Target Prices for all planters under our coverage although our ratings on them would remain unchanged. Maintaining OUTPERFORM on TSH (New TP: RM2.80, Old TP: RM2.95) and UMCCA (New TP: RM7.70, Old TP: RM8.05) for their double-digit FFB growth prospects. Maintaining MARKET PERFORM on SIME (New TP RM9.80, Old TP: RM10.30), IOICORP (New TP: RM5.15, Old TP: RM5.25), KLK (New TP: RM22.30, Old TP: RM24.86), GENP (New TP: RM9.25, Old TP: RM9.70) and IJMP (New TP: RM3.38, Old TP: RM3.65), and an UNDERPERFORM on TAANN (New TP: RM3.60, Old TP: RM3.75) due to its timber division weakness.

New record high inventory at 2.48m mt.  Sep-12 inventory jumped 17% MoM to 2.48m mt and this was higher than both the consensus' estimate of 2.45m mt and our estimate of 2.43m mt. The new record set was 9% higher than the previous record high inventory of 2.27m mt registered in Nov-08. As the production growth of 20% MoM exceeds exports growth of 5% MoM, the stocks-to-usage ratio jumped significantly to 12.4% in Sep-12 (from 10.9% in Aug-12). The stocks-to-usage ratio remained way above its 3-year average level of 9.6%, suggesting ample CPO supply in the system and hence limited near-term price upside.

Expecting higher inventory in Oct before start to decline in Nov. We expect the production growth to continue in Oct albeit at a slower rate of 2% MoM to be followed by a production decline from Nov onwards. Hence, the Oct inventory level should hit another record high at between 2.6m-2.8m mt based on our preliminary estimate. However, inventory should decline from Nov onwards due to lower productions and an expected higher demand in view of the Deepavali festival then. Hence, CPO prices should improve from Nov onwards.

Both 2012-2013 CPO price assumptions cut by 6%-3% to RM2,975-RM3,000. Our previous assumption was RM3,150 for 2012 and RM3,100 for 2013. Based on our CPO price forecast model using the multi-regression method, we have now assumed a higher ending inventory of 2.28m-2.05m mt for 2012-2013. Due to our lower CPO price forecasts, our FY12/13E earnings for the plantation companies have been reduced by 2%-10% with FY13/14E earnings lowered by 2%-6%. Despite the unexciting FY12/13E earnings growth, things should be better in FY13/14E as CPO prices should improve slightly. 

CPO prices supported by high discount to soybean oil, lower inventory from Nov onwards and biodiesel usage. The current high discount of US$350/mt against soybean oil should drive more demand on CPO from price-sensitive countries such as China, India and Pakistan. Note that the current discount is more than doubled the 5-year average discount of US$158/mt. We think the current high discount is explained by the peak production season but reckon that it should only continue for another one month. Once production starts to decline in Nov and resulting in lower inventories, CPO prices  should recover as its discount against soybean oil shrink. On top of this, Malaysia has pledged to increase its biodiesel usage according to media news. All these should bode well for CPO prices.

Source: Kenanga