We are maintaining our NEUTRAL view on the plantation sector with our CPO price estimates unchanged at RM2500/mt for CY2013 and RM2700/mt for CY2014. Our previous optimism on the sustained inventory decline was neutralised by the weak soybean oil prices, lower crude oil prices and the  strengthening US Dollar. For Malaysian palm oil inventory, we expect it to register a sixth consecutive decline in Jun-2013 to 1.75m mt and this should be supportive  to CPO prices. However, bumper soybean crops from South America have pressured soybean oil prices (down 9% YTD) and this should limit the CPO price upside. Lastly, our economist has now assumed lower crude oil prices and a higher USDMYR rate after the US Federal Reserve reaffirmed its intention to start scaling back its Quantitative Easing (QE) program in the next few months (both will have negative impacts to CPO prices). In the current low CPO price environment, we believe that only planters with high FFB growth will be able to deliver earnings growth. Hence, we have OUTPERFORMs on IJMP and TSH, which have so far registered 43% and 45% in FFB growths respectively in 1QCY13. After imputing the higher FFB productions, we have increased our Target Prices for IJMP (New TP: RM3.50, Old TP: RM3.38) and TSH (New TP: RM2.60, Old TP: RM2.44). We also have an OUTPERFORM rating on PPB (TP: RM15.20) as we expect it to benefit from Wilmar’s earnings recovery. We are maintaining MARKET PERFORM calls on SIME (TP: RM9.80), IOICORP (TP: RM5.40), KLK (TP: RM21.86), FGVH (TP: RM4.60), GENP (TP: RM9.85) and UMCCA (TP: RM7.55). However, we continue to recommend an UNDERPERFORM on TAANN (TP: RM3.55) due to its high operating cost issue. 

Sustained inventory decline is supportive to CPO prices. Malaysia’s palm oil inventory level declined for the fifth consecutive month to 1.82m mt in May-2013. Note that for the first five months of 2013, strong palm oil exports of 7.42m mt has outpaced the production level of 6.97m mt. In the near term, we believe that the inventory level should continue to decline by 4% MoM to 1.75m mt in Jun-2013. We expect strong demands for palm oil due to the stock-up activity ahead of Ramadhan and the warm weather in the Northern Hemisphere. Note that palm oil is used more during the warm weather period as it tends to solidify in cold temperature. On the overall, we have reduced our end-2013 inventory level estimate to 2.18m mt due to the stronger than expected exports so far. 

However, weak soybean oil prices limiting the CPO price upside. We gather that soybean oil prices have declined 9% YTD to 46.66 US cents per pound (as of 21 st Jun) due to the bumper soybean crop from South America. According to Oil World estimate, soybean output from South America has surged 24% YoY to 145.93m mt in the 2012/2013 season. Looking ahead, post the South America production season (which should have ended in Jun), the prospect for soybean oil prices does not look great as Oil World is expecting a strong United States soybean production growth of 12% YoY to 92.0m mt. As a result, we have lowered our soybean oil price input in our CPO price model to USD0.48 per pound (against USD0.51 previously). On the overall, the low soybean oil prices will limit the CPO price upside as both are common substitutes to each other. 

Lower crude oil price and higher US Dollar may curb CPO price increase. Our economist has increased his forecast of the average USDMYR rate to 3.09 (from 3.05) and lowered his crude oil price estimate to USD95.06 per barrel (from USD97.5) for 2013. This is in line with the US Federal Reserve reaffirmation of its intention to start scaling back its Quantitative Easing (QE) program in the next few months. Both these factors (lower crude oil prices and higher US Dollar) should keep the CPO price upside limited. 

Prefer IJMP and TSH due to their superior FFB production growth, PPB may benefit from Wilmar’s earnings recovery. In 1QCY13, both IJMP and TSH delivered the highest FFB growth rates YoY at 43% and 45% respectively. Their superior FFB growth has allowed these two companies to register good earnings growth YoY despite the CPO price declining 28% YoY. As FFB growth is caused by the structural advantage of having young oil palm trees, we believe the trend of the high FFB growth can be sustained throughout 2013, thus continuing to support their earnings. As for PPB, we believe that it should benefit from Wilmar’s margin recovery in its China soybean crushing division.

Source: Kenanga