Malaysia’s palm oil inventory level of 1.65m mt for Jun-13 came in 6% below the market expectation of 1.75m mt as Sabah’s production unexpectedly dropped 8% MoM due to worse than expected tree stress. MoM, inventory slipped 9% as the total demand (exports + domestic disappearance) of  1.53m mt continued to exceed the total supply (production + imports) of 1.43m mt. The news by itself is positive for CPO prices, but we think sentiment may be dampened by cargo surveyor’s data that palm oil export declined 16% MoM for the first 10 days of July. Looking ahead, we believe that the stock level could fall 3% MoM to 1.60m mt by July-13 as the total demand should stay strong at a level similar to June. Despite normalizing demand from India and Pakistan  post-Ramadhan stock up activities, potential increase in demand from China due to its warmer weather may neutralise the impact. Overall, we view the latest inventory data as mildly positive and we expect CPO prices to recover in the near term. 

Maintain NEUTRAL on the sector with our current CY13-CY14 average CPO price forecasts of RM2,500/mt-RM2,700/mt unchanged. However, we may consider upgrading the sector to OVERWEIGHT if La Nina is confirmed. Our top pick is IJMP (OP; TP: RM3.50) as its 2QCY13 FFB growth of 39% YoY should be the highest among planters under our coverage. We also have OUTPERFORM calls on TSH (TP: RM2.60) and PPB (TP: RM15.20). We like TSH for its high FFB output growth while PPB is poised to benefit from Wilmar’s earnings recovery. Maintain MARKET PERFORM 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). Maintain UNDERPERFORM on TAANN (TP: RM3.55) due to its high cost issue.

Inventory level lower than expected. The latest MPOB inventory data showed stocks level in Jun-13 declining by 9% MoM to 1.65m mt (the lowest in 27-months since March-2011). It is also 6% below the consensus estimate of 1.75m mt. Palm oil total demand (exports + domestic disappearance) of 1.62m mt continues to exceed total supply (production + imports) of 1.45m mt and this caused stocks level to deplete significantly by another 0.17m mt. Stock/usage ratio has tightened MoM to 8.5% (from 9.9% last month) and is currently almost equal to the 8.4% recorded in Jun-2012. The news by itself is positive to CPO prices, but we think sentiment may be dampened slightly by the cargo surveyor’s data that palm oil export declined 16% MoM for the first 10 days of July.

Stocks may fall to 1.60m mt in July-2013. We forecast total demand of 1.62m mt in July-13 to stay ahead of total supply of 1.57m mt,  hence depleting inventory by another 0.05m mt. In July, we think exports should stay strong at a level similar to June. Despite normalizing demand from India and Pakistan post-Ramadhan stock up activities, potential increase in demand from China (due to warmer weather) may neutralise the impact. On the supply side, we have assumed 8% production increase MoM in line with seasonal trend. While continuous downtrend in CPO inventory level is positive to CPO prices, low soybean oil prices and the strengthening of USD may limit CPO price upside.

Tree stress is now confirmed, watch out for La Nina. The 4% YoY production drop in Jun-13 is the first decline in 10 months. Sabah palm oil production was the worst hit with 8% decline MoM and 5% decline YoY to 387k mt. As a result of strong FFB production in 4QCY12 and 1QCY13, we believe the tree stress effects have started in Sabah and other parts of Malaysia. At this juncture, we believe the tree stress effects should be minimal, but it may cause 2H13 palm oil production to be lower than 2H12. Nevertheless, we believe La Nina should be monitored closely as it could cause a supply shock in 2H13 if it happens during the tree stress period. While weather expert is still suggesting neutral weather in 2H13, the appearance of La Nina cannot be totally ruled out yet. 

Top pick is IJMP.  We believe IJMP’s 2QCY13 earnings should outperform its peers due to superior FFB volume growth of 39% YoY to 148,071 mt. In our view, IJMP 2QCY13 FFB volume growth is likely to be the highest among its peers.

Source: Kenanga